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Tuesday, June 19, 2018

Office Market on the Upstream

By Rand Stephens (Houston)

While the industrial market is thriving in Houston, the office market is moving at a slower pace. For eight of the last nine quarters, there has been negative direct net absorption. The direct vacancy rate is at an all-time high of 16.2% for the first quarter of 2018, and the combined direct and sublease availability rate is at 22.4%. Meanwhile, the industrial market has remained below a 5% vacancy rate and the momentum fueled by distribution centers and robust activity around the Port of Houston continues.  Oil prices are above $65 a barrel and the unemployment rate in the Houston Metro Area is down from 5.4% in 2017, to 4.2% today.  So, why the lopsided recovery among the industrial and office sectors?

The answer is energy efficiency – and not the kind that reduces your light bill. The energy industry is becoming more efficient and shrinking their office footprint by doing more business with less people, thus, easing the need for office space. Houston’s biggest oil and gas companies have scaled back and consolidated their office spaces as they cautiously emerge from the downturn. The average-sized deal has decreased by roughly 10,000 square feet and although more deals are being made, they are smaller in size.

Traditionally, when the oil industry is flourishing, it has a ripple effect throughout the Houston economy, including commercial real estate. And, most economic sectors have seen an improvement. However, it’s going to take more than just an increase in oil prices to have a positive impact on energy jobs and office space.  The office market, particularly along the Energy Corridor, is shaped by the upstream industry.  Drilling in the Gulf of Mexico and other deep waters has decelerated considerably since 2010, but the administration is offering lower royalty rates for offshore activities and larger tracts for bidding in an effort to revitalize exploration and production.  Office activity is likely to see a boost as more offshore projects are launched.

Shell's Appomattox platform in the Gulf of Mexico
It is encouraging to see major energy companies such as Royal Dutch Shell, BP and Exxon Mobil announce exploration projects in the Gulf and the Mediterranean.  Shell recently completed and launched their new deepwater Appomattox  platform in the Gulf and also discovered the Dover well about 13 miles from the Appomattox. That’s Shell’s sixth discovery in the Norphlet region of the Gulf. BP is also working on the Mad Dog Phase 2 platform, which is expected to produce first oil by 2021. 

The anemic upstream activity of recent years did not bode well for the office market, but these projects indicate that there is light at the end of the tunnel.  The office market will stabilize as opportunities for job creation and added space by the energy industry increase. It’s going to take some time, but it’s headed in the right direction.

 (Rand Stephens is a Principal of Avison Young and Managing Director of the company’s Houston office.)

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