Oil-Intensive Tenants Land CRE on Shaky Floor

O’Donnell says as leases expire, most companies are downsizing and retaining less space.

HOUSTON—With slightly more than half of all Houston office space occupied by energy or engineering companies, the vitality of the energy market is always a primary concern for the office market’s health and occupancy. As evidenced by the negative cash flows of major publicly traded energy corporations, the plunge in oil prices that commenced in late 2014 cannot support or sustain the industry, says a report by Savills Studley . Although the price of oil may have finally found a floor–oil prices hovered between $35 and $40 per barrel for much of the quarter–there is no recovery in sight for the energy industry. The North American rig count sank to 450 by the end of the first quarter. According to Baker Hughes , this was the lowest count since tracking began in 1949 and marked an ominous drop of 56.2% from a count of 1,028 just one year prior. Maintaining an oil price floor is pivotal in order to avoid continued weakening in the office market. However, the floor will likely be tested as equity markets remain turbulent and investors implement varying long- and short-term strategies that can spur fluctuation. The weakness in the energy market is a two-sided affair. Above and beyond the supply glut, the economic slowdown in China and other emerging markets continues to curb demand. United States producers have kept an eye on OPEC ‘s decision-making to see whether the organization will curb production. OPEC initiated a production freeze in the first quarter, which helped prices rebound from a brief dip to $28 per barrel. In March, however, OPEC oil production rose as growth in Iranian and Iraqi output outpaced outages in Saudi Arabia and other associated producers. So long as the world continues to contribute to a growing supply glut, the price of oil cannot rebound and Houston’s energy employment will not return to previous levels, says Savills Studley. Indeed, the overall Houston unemployment rate crept up quarter-over-quarter from 4.6% to 4.8% as employment gains in non-energy sectors failed to keep pace relative to energy losses. In contrast, West Houston’s CBD is partially buffered from an energy lull. Only half of its occupied square footage is held by energy and engineering firms (in contrast to roughly 90% for the Katy Freeway submarket). Not coincidentally, the CBD had some of the area’s largest leases from non-energy companies. Kirkland & Ellis signed on to be the anchor tenant at 609 Main, the Hines development that will deliver at year-end 2016. The firm, which will relocate from 600 Travis, finalized a lease for 62,000 sf. United Airlines will reportedly take 235,000 square feet in the same new development rather than renew at 1600 Smith and 600 Jefferson. Availability in the Katy Freeway submarket continued to escalate. The overall availability rate surpassed the 30% threshold and closed the first quarter at 31.2%, the second-highest rate in the market (only surpassed by the Greenspoint submarket). The rise in Katy Freeway’s availability rate during the past three years demonstrates the effects of the submarket’s twofold problem of overdevelopment and soft demand from energy companies. The rate has climbed steadily from 6.9% in 2013 to 14.1% in 2014 and up to 26% at this time last year, according to the Savills Studley report. Mark O’Donnell , executive vice president, director of Savills Studley tells GlobeSt.com: “Availability is due primarily to three things: 1. Several energy companies have reduced their workforces and in many cases those companies leased excess space for growth prior to energy price declines and are now faced with an oversupply of space–many of those companies are subleasing space; 2. Several newly constructed buildings have come on line and have had little to no leases signed and 3. As leases expire, most companies are downsizing their footprint and retaining less space.” Weak demand from a downtrodden energy sector will continue to subdue the overall Houston office market through the rest of 2016. Tenants with a strong bottom line or an energy-independent business model may plan to take advantage of the tenant-friendly marketplace during the year and strike new or renegotiated leases at favorable terms. Lease comparables will likely continue to descend and asking rental rates may even fall in concert with actual negotiated deals, predicts Savills Studley. Those tenants reliant upon a quick energy upswing may need to look forward to 2017 or beyond. In the meantime, it is not a matter of “if” but “when” more sublease space hits the market. Significant amounts of leased, but unused shadow space should continue to open up as tenants move or shed space through mergers and acquisitions, downsizing or bankruptcy.