Houston Industrial Market Poised To Tighten As Demand Rises, Construction Starts Slow

Houston’s industrial market has been in the midst of a major development wave for the past year or two, but finally, the delivery pipeline is starting to wane.

At the same time, the city is experiencing robust demand for industrial space as retailers, supply chain and third-party logistics firms continue to expand their offerings in the wake of the coronavirus pandemic. 

The demand is already translating into rising absorption and lower vacancy rates. And while the market is likely to remain tenant-favorable through the end of the year, that leverage is expected to shift as space gets snapped up.

“We're off to an extremely hot start. And the tenant demand is the highest that I've ever seen in this marketplace,” CBRE First Vice President Nathan Wynne said.

The first quarter of 2021 carried over much of the momentum from the end of 2020. Leasing activity totaled 6.7M SF, 16% above the five-year quarterly average of 5.8M SF, according to JLL’s latest industrial market report.

Rooms To Go signed the biggest lease of the quarter, inking a deal for a 498.2K SF space in the west submarket. In addition, an unnamed e-commerce retailer signed for about 1.1M SF of industrial space during Q1 alone. Based on the pace it is signing deals around the country, that retailer is likely to be Amazon. 

The positive drivers for the sector that facilitated a boom in industrial deal-making at the end of 2020 have carried through to 2021, according to Wynne.

“The constant uptick in e-commerce growth, food and beverage, and just 3PL [third-party logistics] activity in general all contributed to major growth in the industrial sector,” Wynne said. 

Despite the flurry of deal-making, Houston’s industrial vacancy rate increased in Q1, reflecting the delivery of multiple large speculative projects that were only about one-third pre-leased. The citywide vacancy rate rose to 9.2%, up from 8.8% in Q4 2020, according to NAI Partners’ latest industrial market report. Net absorption amounted to 591K SF, down from 6.3M SF in Q4 2020.

A record-breaking 31.8M SF of industrial project delivered in 2020, flooding the market with a wealth of new space. But brokers say the construction pipeline is starting to slow down as ideal land parcels for industrial development become scarce and construction costs continue to rise to unprecedented levels.

As a result, there is a rising belief that vacancy rates have reached the peak of the cycle and are likely to fall rapidly in the coming months. 

Deliveries in Q1 totaled 3.1M SF, which was 22% lower than the five-year quarterly average, JLL said. At the same time, 8.6M SF of industrial project broke ground in Q1, bringing Houston’s industrial construction pipeline to 13.3M SF. About 61.5% of that is pre-leased, which is expected to translate into greater occupancy gains in the coming quarters. 

Stream Realty Partners Senior Vice President Jeremy Lumbreras said the industry is in limbo, waiting for the quarterly figures to reflect the shift in supply and demand. Once it does, Lumbreras expects Houston’s citywide industrial vacancy rate to decline significantly.

“Even though there's still more development coming, albeit at a smaller pace, you're going to see that vacancy continue to nosedive over the rest of the year,” Lumbreras said.

In a first for Houston, three buildings larger than 1M SF broke ground during Q1 2021: a 1.5M SF building for Lowe’s in the north submarket, 1.5M SF for Floor & Décor in the southeast and 1.1M SF for an unnamed e-commerce company in the southwest, according to JLL.

Wynne said he has seen a noticeable uptick in the average square footage of industrial deals being done over the last 24 months. The bulk of that growth is happening in the 250K SF to 750K SF range, though there has also been an increase in the number of deals that involve properties of 1M SF or more.

“We really didn't have a lot of deal velocity in that size range. And all of a sudden, that seems to be a sweet spot for Houston,” Wynne said.

Lumbreras said the growing size of deals is a reflection of Houston’s population growth, which is driving demand locally for consumer goods. Census data released Monday shows Texas’ population has swelled 16% in the last decade; metro-by-metro data hasn’t been released yet, but Houston has been a significant contributor to that growth.

“As Houston's population continues to grow, there's just more and more need to store in-house products to service the local population. And as we continue to grow, I think it's a trend that's going to keep getting bigger and bigger,” Lumbreras said.

A growing struggle for industrial developers is finding suitable tracts of land in major submarkets. That difficulty has contributed to the slowing rate of industrial construction starts in Houston and the beginnings of a tightening market, according to Wynne.

“We've gobbled up a lot of the premier shovel-ready sites. And so, finding a developable land site has gotten much more difficult for developers and has started to take a lot more time from a development process standpoint,” Wynne said.

Lumbreras noted that at this stage, it’s almost impossible to find 20 to 30 acres in northwest Houston, and what is available is priced far too high per square foot for an industrial development. That’s forcing groups to look farther out of the city, where there is still land along major freeways — but that land tends to lack utilities or infrastructure.

“If you were able to get a development out of the ground, then you would be able to charge a higher [rental] rate, just because there's no other supply, no other competition,” Lumbreras said.

The soaring cost of construction materials and lengthening lead times have also made it difficult for developers to move forward with some industrial projects. Wynne said those factors have already caused the market to tighten, particularly for bulk spaces.

“It’s been a combination of lack of shovel-ready sites and also major steel increases. And timing on steel has impacted development tremendously,” Wynne said. “The buildings of size that are on the ground ready to go, in my eyes, have a distinct advantage — more so now than they ever have.”

Lumbreras said the high costs are making it more difficult for developers and build-to-suit clients to justify projects, which will have an impact on what comes out of the ground in the future.

“You talk to a GC [general contractor] and there's no real end in sight, we just don't know when it's going to level off because there's a backlog everywhere,” Lumbreras said.

After a year of the pandemic, vaccinations began rolling out at an accelerated pace during Q1. That has led to more in-person shopping and dining, as some consumers opt to embrace their old habits. 

But even though people are returning to brick-and-mortar retail stores, both Wynne and Lumbreras said that e-commerce demand is unlikely to falter or hurt the industrial sector in a meaningful way.

Wynne said that from a high-level standpoint, retailers like Amazon still have a lot of room to grow in the Houston market and are likely to continue being very active.

“Most of the population, from what I can tell, has gotten into a comfortable zone as it pertains to online shopping. And so, I don't expect it to slow down at all,” Wynne said.

Lumbreras said it feels like Houston is only in the early innings of its e-commerce game.

“Some of [the] other major markets that Stream is in, there's been overwhelming activity. And I think when you actually look at the users that are leasing space in Houston, not a lot of them are e-commerce-related yet. I think it's coming,” Lumbreras said.