OFFICE MARKET ASSESSMENT
Houston’s office market fundamentals continue to show modest signs of improvement. The office sector registered positive absorption for the third straight quarter with 159k SF of direct space absorbed in Q2, improving the trailing 12-months total to 948k SF of occupancy gains.
The Class A sector accounted for the bulk of the gains with 156k SF of direct space absorbed in Q2, marking the third consecutive quarter of absorption growth totaling 1.4M SF, which has helped reduce the direct vacancy rate by 70 bps to 24.9% since hitting its cyclical peak in 4Q 2021. Noteworthy move-ins contributing to the absorption gains included UT Physicians (139k SF at Bellaire Station), Weaver Tidwell (61k SF at Five Post Oak Park), Entergy (54k SF at Lake Front North), Linde PLC (41k SF at Sierra Pines I), and DLA Piper LLP (32k SF at Texas Tower).
Leasing volume totaled 2.6M SF in Q2 but remains 41.1% below the pre-pandemic quarterly average from 2017-2019 due to the combination of many firms trending towards smaller footprints and the lack of large new deal and expansion activity.
The flight-to-quality trend remains prevalent as tenants continue to prioritize highly amenitized buildings containing fitness complexes, dining options serving up chef-inspired food, rooftop gardens, and finishes in interior and exterior commons areas that are noticeably distinguishable from lower-end or older Class A buildings.
Landlords continue to hold firm on face rates but the gap between asking and effective rates remains significant as highly competitive concession packages with rental abatement and tenant improvement allowances, aimed at attracting and retaining tenancy.
New supply continues to capture a large share of the demand, as 25.7% of the YTD leasing activity has occurred in buildings delivered since 2015 and contributed to all the absorption gains. The largest deal inked in Q2 involved Cheniere Energy’s 151k SF new lease at Texas Tower, which brings the newly built trophy tower up to 62.4% leased.
Sublease availability remains elevated at 7.9M SF but has slightly declined since hitting its peak at mid-year 2021. Even though many companies have already rightsized their footprint to adjust to a post-pandemic environment, some occupiers are still exploring ways to optimize and reconfigure their workspace to meet new challenges and work patterns.
Developers delivered 122k SF of new product in Q2, bringing the YTD total to 802k SF. New construction remains active with 2.0M SF underway currently 20% pre-leased with 567k SF of this new product slated to deliver by year-end 2022. As the office market recovery gathers steam in the coming quarters, newer and amenity-rich Class A office product in prime locations will continue to outperform the broader market in demand, occupancy, and rents at the expense of older buildings.
Employment indicators and consumer spending have remained strong through the first half of 2022 however, higher inflation expectations continue to undermine consumer confidence. The Federal Reserve is now engaging in a sharp tightening of monetary policy. Higher interest rates will cool private investment and reduce consumer purchasing power. Even still, there remains pent up demand which should help improve leasing fundamentals and generate more occupancy as occupiers get more certainty on their longer-term space needs.