Industrial Development In Houston Now Requires ‘Turning Over A Lot More Rocks’

Even the industrial market, the shining star of Houston’s asset classes, is requiring creativity and diligence to push deals past the finish line these days.

Business is still strong, said Robert Clay, Clay Development & Construction president and co-founder and the keynote speaker at Bisnow’s Houston Industrial and Port Update, held at The Westin Houston Memorial City on Thursday. 

Clay’s business is developing 1.5M to 2M SF of spec distribution space every 18 months or so, he said. Meanwhile, industrial development in the city overall is consistent and increasing. Houston gained 7.8M SF of industrial space in the first quarter, more than double what it gained in Q1 2022, according to a CBRE report.

But despite industrial’s upper hand in an otherwise turbulent market, it is “in a little bit of a slow patch,” Clay said, facing many of the same challenges as the broader commercial real estate industry.

Markets are demanding a 7% yield on cost, and that has become harder to achieve, Constellation Real Estate Partners partner J.W. Fields said.

“When you factor in what construction costs have been in the past 12 to 18 months and land sellers’ expectations, it’s really, really challenging to get the numbers to work,” Fields said. “One way we’re solving for that 7% is just turning over a lot more rocks.” 

That includes finding sites that have been overlooked for various reasons, including those that are part of a flood plain or have utility challenges, he said. The most critical component is finding willing land sellers, Fields said.

Rising construction costs are somewhat offset by rising rents, Lovett Industrial Director Austin Rios said. Average gross rental rates climbed to 78 cents per SF on a monthly basis, reflecting a 19.4% increase from Q1 2022, according to CBRE’s April report. That is up from an average of 59 cents in 2020. 

“Beyond that, I think you just need to get creative,” Rios said. “A lot of the deals that we see are getting traction in our office are deals that are either off-market or ones that have been ignored for a while.” 

Once developers get hold of the land, it is important to maximize the footprint there and make the site efficient, he said. 

“It's more so focusing on things that will get your site ready to go out to capital in shovel-ready [condition], within a very short fuse,” Rios said. “I think that a lot of these folks today on the capital side want a site that is shovel-ready, ready to go tomorrow.” 

There are many more things to consider when securing capital today than 18 months ago, Ryan Vice President of Industrial Development Matt Hyman said. 

“It's got to be ready to go right away,” Hyman said. “They don't want to carry the land at all. No entitlement risk. It's got to be on a major thoroughfare, probably on the freeway.”

Where once projects built on spec proliferated, Hyman warned, those pulling up to completed but not-yet-leased buildings are questioning why they were built. 

“You actually have to think about those questions now,” he said. “Before it was like, 'We don’t even really need a lease and we’ll make money.' Now it’s like, ‘OK, we actually have to lease this, and we need to be able to get to the building. We probably need a road now.’ You may not have needed that before.” 

Even so, the sky isn't falling. The growth of Port Houston, which has taken container traffic away from Los Angeles and Long Beach, has boosted the way Houston is viewed, JLL Senior Managing Director Trent Agnew said.

Port Houston is the fastest-growing container port in the country, partly because of traffic diversion from the West Coast, but also because of Texas’ growth, Port Houston Chief Commercial Officer John Moseley said. 

“We dropped out from this huge spike last year, but the sky is definitely not falling,” Moseley said. “We're looking actually a lot better than just about everyone else in the country. If you look at the Port of Los Angeles’ website, the No. 1 container port in the country, they're down 25% year-to-date. We're up 1%.” 

Port Houston services not just the Texas Triangle but also the middle U.S., Provident Realty Advisors Director of Development and Acquisitions Christen Vestal said. There are 110 million people outside of Texas served by the port, she said. 

“So from a capital standpoint, I think we're in as good of a spot as we've been in a long time,” Agnew said. “Our transaction volume, albeit nationally, was down 40% in the first quarter. We've got a number of things out, and we're routinely seeing 10, 15, 20 bids on pretty much anything that we take to market right now. So the depth is there … and it feels really, really good to be in Houston.” 

“Industrial’s easy. It’s good,” Clay said. “The people in it are good. It’s a simple business. … It’s just a good, easy business, and e-commerce has been the godsend for industrial real estate, and distribution specifically.”