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Houston’s CRE Market Showing Stress from Falling Oil Prices

Surge in Office Sublet Space is First Sign of Market Weakeness
January 27, 2016
After demonstrating surprising resilience, the Houston real estate market is starting to show wear and tear 18 months after oil prices began their historic decline, having now fallen nearly 75% from previous highs.

Houston's economy has diversified over the past decade, but it is still a global energy capital. Signs of stress are beginning to appear in the form of record amounts of sublease office space as companies with exposure to the energy sector have begun downsizing. In addition, Houston's office market, which led the U.S. out of recession when oil prices were high, saw record amounts of new space deliveries the last two years totaling nearly 22 million square feet, according to CoStar data.

The office sublease vacancy rate - a forward looking indicator -- has tripled from 0.4% at the end of 2010 to 1.2% today. The overall office vacancy rate has jumped dramatically since the third quarter of 2014, from 10.75% to just under 13.5% today. Overall, asking rents for office space in Houston have flattened over the last five quarters.

Office market fundamentals are expected to worsen with continued outlook for depressed energy prices through 2016.

"Office space is the big bogeyman out there right now," said Sam Kendricks, chief credit risk officer of Hancock Holding, a bank holding company based in Mississippi with bank branches in Texas. "Office space is the one that is having particular difficulty right now. All-in-all, we expect to see some degradation as we move to 2016 given the pressures on the [energy] industry. But to-date it has been somewhat muted.”

The impact from the decline in oil prices is also being felt in office building sales. Investors were bullish on the market last year, when total office sales volume of more than $15 billion was the highest total in five years. However, the average per square foot sales price has been trending down after reaching a peak of about $280/square foot at the end of 2012 to an average of approximately $145 at the end of 2015.

Prices for Houston office buildings could go lower, too. CBRE is predicting that office cap rates could increase as much as 25 basis points this year for sales of Class B and C office properties in the Houston market.

Retail, Industrial Remain Strong as Multifamily Feels Impact

Keith Cargill, president and CEO of Texas Capital Bancshares said that overall market intelligence by his firm indicates the industrial and retail sectors in Houston remain fundamentally strong, with the ripple effects from falling oil prices largely confined to the office and also multifamily sector.

Homebuilders are also cautious about 2016. National homebuilder KB Homes reported slowing planned construction starts after home sales were off in Houston in the past quarter.

"Our community count was down year-over-year and it was really with intent," said Jeff Mezger, president and CEO for KB Home. "We pulled back on investment early in the year when oil started to slide down and decided to take some chips off the table until things stabilize and there’s clarity to the market."

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