It Feels Like 2021 Again For Houston Industrial Despite Tariffs, High Land Prices And The Fight For Capital
Houston's industrial market is facing some challenges.
President Donald Trump's on-again, off-again approach to tariffs is adding a layer of difficulty to Houston’s tight industrial development market, where high land prices and hot demand were already creating stiff competition. Securing financing remains a battle, and the local electricity provider regularly takes a year or more to power up a site.
Yet panelists at Bisnow’s Future of Houston Industrial event Thursday said the city’s industrial market is one of the strongest in the country, arguing it is worth the due diligence required to develop in it.
“It feels a little bit like ’21, ’22 within Houston,” Newmark Executive Managing Director David Claros said, referring to the pandemic-driven industrial boom that brought record-high industrial construction and leasing activity to Houston.
“The fundamentals are really good,” Claros said. “Huge land grab. I’ve definitely lost more [sites] than I’ve won.”
Heated competition is happening despite land being overpriced, said panelists at the event, held at The Westin Houston Memorial City.
“They’re higher than they need to be,” Copeland Rhea, director of leasing and new market development for Clay Development & Construction, said of prices. “We run into this a lot, where the expectations of sellers are such that they've gotten offers from different companies that can't perform.”
Due diligence is key given conditions today, especially as issues that come up tend to show why the land should be priced lower or isn’t worth developing at all, Rhea said.
Due diligence has also become the top priority of Blake McClendon, director of construction and Houston market leader for FCL Builders.
“In the last 10 to 12 months, I’ve done maybe $600M worth of due diligence for guys on land plays,” McClendon said. “Some of that’s the big dance, where there’s six, eight guys competing for a land site. … It’s kind of cutthroat.”
A tight market requires more upfront effort from equity investors, developers and contractors. It also makes a civil engineer’s job imperative, to find things like flood plain issues, McClendon said.
If due diligence isn't done correctly, costs can veer too far off from pro formas to keep equity partners happy, McClendon said.
Land prices aren't the only issue. Lead times to secure transformers from CenterPoint Energy are also complicating the planning process for development. Prior to the pandemic, CenterPoint could supply a transformer in eight to 12 weeks. Now it takes 40 to 60 weeks, and it isn't a problem that money can solve, McClendon said.
“A lot of deals have been lost for landlord customers because they can't give the customer the power that they need,” he said.
In addition, developers are still struggling to secure the funding they need to initiate projects. Capital is still active, but highly selective, Constellation Real Estate Partners partner J.W. Fields said.
Securing a capital stack and joint venture partner for a project feels like clearing a hurdle, said Christen Vestal, Provident Realty Advisors director of development and acquisitions. But as cap and interest rates stabilize, rents grow and investments pick up, it will become easier to capitalize projects, she added.
That hasn't happened yet.
“I haven’t seen that, at least,” Vestal said. “You feel like you’re right back to where you started the first time. Every new project, capitalizing is the same struggle.”
On top of that, the Trump administration's intention to implement tariffs — or not — is putting a big question mark over the CRE world.
“Nobody knows what’s going on,” Rhea said. “There’s no certainty as to what the upcharge is going to be on steel or concrete or anything.”
Cost increases are likely, whether that is due to tariffs or suppliers taking advantage of the opportunity, he said.
Soon after Trump took office, McClendon got about five calls a day asking what the policies would mean for different facets of real estate.
“The administration's been kind of flippy-floppy with what they're doing,” he said. “The tariffs are on, the tariffs are off, the tariffs are on again.”
Whatever happens with tariffs, there are already products in the supply chain that will have to be used before their true impact becomes evident, he said.
More elements are working in the market’s favor, though.
“The duration from site identification to getting a shovel in the ground is so much more protracted than it used to be,” Fields said. “In addition to the disciplined capital, I think we’re in a really nice equilibrium. Demand is really outstripping supply.”
Construction activity was at a seven-year low last quarter while net absorption remained strong. Demand is still elevated, especially given a boost in interest from domestic advanced manufacturing and smaller tenants, panelists said.
Houston's average industrial lease size right now is 45K SF, so merchant developers are adjusting their models for smaller tenant deals, McClendon said. Claros said he has put more offers on sub-10-acre plots in the past year than he had in the previous five.
But while there’s a huge demand for smaller manufacturing buildings, not many have been built in the past five to seven years, Rhea said. This creates an opportunity for developers to get into a segment that is more than 98% occupied.
“The problem has been that land costs have been too high, construction costs have been too high, and the rents haven't grown to offset that,” he said. “Now we will be seeing rent growth because of the vacancy rate being so low.”
Houston continues to gain attention nationally because of its leasing and rent growth metrics, Northmarq Senior Director of Debt and Equity Warren Hitchcock said, adding it is simply outperforming other markets.
“Some of these other [markets] haven’t been doing so well because they’re so overbuilt,” Hitchcock said. “Dallas has twice the construction pipeline and significantly less absorption. There’s a lot of positives here.”
