Houston Industrial Developers Plan For Next Demand Cycle As Smaller Tenants Boost Absorption

Houston industrial vacancy has increased as millions of square feet deliver and occupiers exercise more caution. That vacancy is likely to keep climbing before it falls.

Yet it’s hard to paint Houston’s industrial market with a broad brush, according to panelists at Bisnow’s Houston Industrial Pulse event on Wednesday at the Omni Houston Hotel.

Houston’s industrial vacancy is just below 8%, but discounting recent deliveries of 450K SF or bigger, it’s closer to 5.5%, Stream Realty Partners Executive Managing Director Matteson Hamilton said.

“Owners that own product south of 100K SF, it’s still really tight, and they have really good opportunity to experience continued rent growth,” he said.

Despite inflated vacancy in the broader market, some rental rates are still rising and construction starts are substantially decreasing, panelists said. That's made many confident in the Houston industrial market’s ability to absorb new space, supporting a belief that a potential severe supply shortage will pop up late next year. 

“Everyone gets wrapped up in vacancy, and there’s no doubt that vacancy will continue to go up,” Hamilton said. “I think it peaks in the end of the second quarter. But you need to peel back the onion a little bit.” 

Owners doing average deals of 15K SF to 25K SF are unaffected by the higher vacancy in larger product, meaning their supply and demand fundamentals and rent growth are healthy, he said. 

Some larger industrial products are still delivering. Project completions in 2023 were 41% higher than in 2022, coming in at a record 32.4M SF of deliveries, according to Avison Young. 

During the peak of the pandemic, when supply chains were strained to the greatest degree, 1M-plus SF buildings gained popularity in Houston, said Trammell Crow Co. Senior Vice President George Farish.

“I think that moment has passed,” Farish said. “Now the pendulum has swung back.”

Nationally and locally, demand for industrial space over 1M SF dropped off significantly in 2023. In 2022, there were 63 deals over 1M SF in the U.S., and in 2023, there were 43, said CBRE Vice President Faron Wiley. The numbers are even starker in Houston, coming in at six and zero, respectively. 

Absorption also dropped from about 30M SF in 2022 to under 20M SF in 2023, the Avison Young report shows.

The market has responded, and construction of big-box buildings and industrial buildings in general has largely halted, said Bradley Kluever, market leader and regional director for First Industrial Realty Trust.

“Starts have fallen off a cliff,” he said, adding that construction is down 50% from the peak in 2023. 

The 250K-plus tenants have also been quiet, but those in the market for 50K to 150K remain active, Constellation Real Estate Partners partner J.W. Fields said. With the construction pipeline waning, vacancy in the latter half of 2024 and 2025 should level out and put the market in a good position, he added.

Development has become a challenge due to the difficulty of securing capital, though that strain eased a bit at the start of 2024, Hamilton said. Last year, a developer would be lucky to have one or two groups interested in financing a project, he said. 

So far this year, more groups have expressed interest in lending, but they are requesting “buttoned up” proposals with fully fleshed-out plans, Hamilton said.

Investors that do want to make deals are showing interest in smaller, infill locations, Fields said. If a potential industrial site hasn’t already been developed in Houston, it is likely because it is in a flood plain or faces utility issues or some other challenge, he said.

“We’re having to spend a lot more money upfront trying to figure out that site,” Fields said. “What capital is requesting now is effectively a shovel-ready site.” 

Constellation is spending $200K to $300K upfront to get sites ready for development, he said.

“Rewind the clock 24 months ago, you can flash the site plan and someone would be in,” Fields said. 

The state of the capital markets is pushing developers to be more prudent about doing due diligence and weighing the risks before diving into a project, he said. 

The irony of standoffish investors is that they themselves expect a severe supply shortage by the end of 2025 or early 2026, Hamilton said. Getting a deal capitalized today is difficult, so there is a bit of a disconnect there, he said.

But that opens an opportunity. 

“If you’re an active [limited partner] that will get behind quality sponsorship developers, like a Lovett, or Constellation or many of the others, you’re going to time the market really well,” Hamilton said. 

To deliver for the next demand cycle, shovels need to be in the ground in the next year, said George Craft, a shareholder at Winstead PC law firm.

Commercial real estate in general is still viewed with skepticism, making lenders hesitant, he said.

“But … the time is coming for them and they will have to jump into that,” Craft said.