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Sunday, February 27, 2011

Houston Commercial Real Estate: Are We Out Of The Woods?

I'm asked everyday by my friends in the Houston business community, "how is the real estate business"? Over my 24 year career, I've seen times where it was much worse that it is today. For instance, the vacancy rate in the office market reached 35% in the late 80's, and after 911 and the merchant energy meltdown caused by Enron, the vacancy rate reached 15.7%. During the Great Recession, which began in Houston in the 4th quarter of 2008 (exacerbated by hurricane Ike) and ended 2nd quarter of 2010, vacancy rose to only 14%.

Annual rental rates are currently $22.77 for the overall office market which represents only a 3.5% decline from the market peak in 2008. Houston has now had two consecutive quarters where the vacancy rate has come down, and at the end of the 4th quarter 2010, it stood at 13.4%

In 2011, the office market should remain healthy and experience continued improvement assuming the positive job growth for the city occurs as projected. This should be the case for all product types including industrial and multi-family. Retail is the exception and more complicated to predict as the rapid rise in Internet shopping has left many retailers "over stored", which combined with the drop in consumer spending, does not bode well for future occupancy. However, many retail property owners are shifting their tenant mix to include more restaurants and entertainment venues which is a segment of the retail world that is still doing well. I don't know what you all experience, but whenever my wife and I go out for dinner, it's hard to get a table; eating out still seems to be a big part of every one's budget.

There has been virtually no new construction in any product category since 2008, and unlike many other markets around the country, Houston's developers exercised discipline during the last boom and did not create an oversupply problem. There is no new development on the horizon, as construction financing is basically non-existent.

Sales of investment properties also improved in 2010 as the capital markets stabilized and the availability of debt came back to the market. However, debt and equity have shown caution and discipline and capital has only gone to acquiring high quality assets that have strong occupancy fundamentals or properties in distress that can be bought at significant discounts to their 2006-2007 valuations.

Takeaways:

With no new inventory coming to market, and with improved job growth, Houston may experience a shortage of quality facilities in the not too distant future. As Landlords become more confident, rental rates may spike rapidly. Tenants should work to lock-in rental rates now and push for options to secure space for future growth.
Houston is a great city for making real estate investments. The market fundamentals are sound and with no new inventory on the horizon, owners will have an opportunity to significantly increase rents over the next 2-3 years with even moderate job growth.

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