by Jennifer Raymond, Vice President – Brokerage Services

The national picture of economic health is far different than that of the Houston regional business environment, yet still falling short of Houston business owner’s standards. The Houston region has suffered its share of business and job losses but true to its character, Houston continues to be forward thinking: automating processes before eliminating jobs, creating innovative new solutions instead of cutting back and thoughtfully reassessing investments with a healthy global worldview. For many Americans, this represents a full financial picture which includes commercial real estate. Here is a look at what our experience, analysis and a few good friends think 2010 will reveal.

Economic indicators are showing signs of improvement and real-time data supports a soft and slow improving year for 2010. We are all in the same slow leaking boat today and everyone is keeping expenses reigned in and pursuing new sales orders. Commercial real estate owners continue strategizing to maintain profitability and recognize tenant work-outs as valuable mutual solutions. Traditional plays like consolidating locations, eliminating unprofitable business units and negotiating favorable lease terms are still commonplace. The term “survival of the fittest” has new meaning for business owners in every segment of commercial real estate. Few people have the luxury of sitting this recession out, but the good news is everyone wants to get back to profitability. Fortunately, Houston has remained reasonably stable overall compared to other regions in the U.S. Commercial real estate industry leaders recently met at the annual CCIM Commercial Real Estate Forecast Competition and there were several valuable insights worth sharing.

Economic Indicators

Three indicators closely watched by the Houston market are employment, rig counts and the housing market. As we see improvements in each of these areas, the market will respond accordingly.

Everyone is focused on the loss of jobs in the U.S. since jobs are the number one driver for new development and commercial real estate activity. Relative to other metropolitan areas, the Houston, Texas 10-county region was on the low end of job losses, which were nearly 93,000 for 2009. The Greater Houston Partnership and area economists predict Houston will gain 1,900 jobs in 2010 most of which will occur in the last two quarters of the year. Naturally, residential and commercial development will begin to pick up as companies begin to hire and consumers regain confidence in the market.

Directly related to the Houston office and industrial market are active rig counts, which were down 60% in mid 2009 compared to the 2,000 highs of August 2008 indicating a clear slow in oil production; however, since then rig counts have been steadily rising to 1,476 (up 471 from one year prior) as of early April 2010. Despite Houston’s diversified economy, a significant correlation still exists between rig counts and the demand for oil and natural gas related products and services. A significant portion of the manufacturing, product design, and services to support this demand are provided by Houston businesses – a direct impact on industrial and office absorption.

Housing starts are slow compared to Houston’s typical 30,000 starts a year; however, 2010 is projected to fall between 18,000 to 20,000 starts, per Metrostudy. Fortunately, Houston area home values remained stable while many U.S. housing markets escalated beyond market value during the last economic growth cycle. The energy, healthcare, and international trade industries are well represented in Houston and will drive new talent to relocate from outside Houston and Texas borders. Population in the region is expected to grow from an estimated 5.5 million to 8.5 million by 2025. This growth will inevitably force the ramp up of new construction starts in the near future; however, developers will be more cautious and the growth will occur at a steady pace. Homeowner’s attraction to quality of life suggests the areas of growth will continue to be in Katy, Sugar Land, and Montgomery County.

Market Sectors

Land development has been down since second quarter 2007 and the land bank purging process has been underway since then. Currently, lot inventory sits at 24 months of supply based on average absorption. Well capitalized master plan community developers are quietly scouring the region for the chance to plan their next move – prepare for Houston’s projected population growth and take advantage of favorable land prices. On a smaller scale, lot development will pick up at the end of 2010 as Houston’s pulse strengthens.

The financial markets are much to blame for the lack of land and development deals. The absence of funds for new development and the snail’s pace recovery push timelines even further out increasing pressure on the investors’ returns. Therefore, the impact to current market value of property will be negative. As a result, a significant gap continues to exist between what seller’s expect to sell for and what a buyer can pay for a site.

Vertical development of industrial real estate is slow in the region and will continue on this path until late 2010 when new projects will work their way through the pipeline. The real story will be who will step out and start committing to make deliveries of new improvements in 2011 given the typical eighteen month construction cycle.

The Houston industrial market remains relatively strong despite spots of oversupply and vacancy challenges. Compared to U.S. industrial markets in 2009, Houston finished in the top five in lack of oversupply, net absorption, and assets under construction as a percent of inventory. This is a significant statement, in fact, Houston was the only major U.S. market to not finish 2009 with negative absorption with Chicago posting the worst absorption at -19.0%. Houston only has 0.3% of its total industrial inventory under construction which equals slow, steady, new space entering the market. In terms of empty space, Houston finished 2009 with 6.8% vacancy compared to Boston, Chicago, Inland Empire, Atlanta, and Detroit each posting over 12% vacancy. Lease rates and sale prices of industrial assets continued to be soft in 2009 and we anticipate that trend continuing in 2010 despite overall market health.

The Houston office market remains stable with clear owner pressures. In 2009 Houston finished in the top half of U.S. major office markets in net absorption, vacant space and assets under construction. Houston was only one of six major office markets to finish 2009 with positive absorption with the remaining fifteen finishing from -0.2% to San Francisco Bay at -7.4%. Houston finished 2009 with approximately 2.6 million square feet under construction or 1.0% of its total. Houston also rounded out 2009 sixth in the nation tied with Northern New Jersey at 14% vacancy. Most owners now understand their financial situation and a 3-5% drop in lease rates in transactions being consummated reflects this. Sales of office assets were minimal in 2009; the only increase we anticipate in 2010 over 2009’s activity will be directly attributable to capitalization.

Houston experienced its fair share of hardship in the retail market although not as bad as other large metropolitan areas in the U.S. Vacancy rates rose to 17.6% at the end of 2009 compared to 15.6% in mid 2008. As a result of consumers feeling the effect of the economy and spending less in the stores, many big box retailers filed for bankruptcy after years of extreme growth. Surviving retailers have been quick to respond by taking advantage of reduced rates and higher class spaces in conjunction with changing their business models to accommodate consumers needs. Signs of stabilization in the job market are building consumer confidence gradually and the retail marketplace will heal itself, in time.

New retail development continues to be at the mercy of the financial institutions and absorption of current product. The same holds true for activity in retail investments. Cap rates are the highest we have seen in the market for some time, so investors are on the prowl, yet the fundamentals still remain – investors are seeking quality income producing properties in a great visible location.

Capital markets are still recovering and the life companies and CMBS packages are slowly reentering the market. Sellers want to sell and buyers want to buy, but the nearly 30% expectation gap is still prevalent in the Houston region. As the flow of money returns to the economy and consistent signs of market growth improve, U.S. commercial real estate markets including Houston will pick back up to “new normal” levels, but not as robust as in most recent years without adding new replacement industry to fill this void.

One consistent theme we are seeing this quarter among our expert friends, clients and colleagues is that we will see the bottom in 2010 and recovery is well on its way despite the snails pace at which it will occur. We are hopeful that the old accounting approach of LIFO (last in first out) is synonymous to the Houston region relative to the economic recession and recovery. Growth is inevitable for the region, yet it may be sluggish and steady compared to what we have experienced over the past decade. Everyone is adjusting to the “new norm” and is proceeding with caution, seeking opportunities in the revival period. The financial markets release of funds will set the pace of growth for new development and investment, while economic indicators such as stabilization in jobs and the rise in rig counts will lead to overall activity in commercial real estate industry. Economists predict tremendous population growth and expansion of job centers in the Houston area over the next 20 years. This population growth will increase the demand for housing, as well as goods and services. This demand will drive the need for office, industrial and retail centers as well as new residential neighborhoods. As first quarter comes to an end the outlook for the remainder of 2010 looks slow, but promising. Be patient, smart, diligent and flexible as we continue to look for improving market conditions and commercial real estate opportunities to come.

Contact:

Jennifer Raymond
Vice President Brokerage Services
281.207.3707
jraymond@icotexas.com