Houston’s Office Vacancy Is Record Levels Of Bleak, And Next Quarter Could Be Worse

Houston’s office market is notoriously cyclical, mirroring the highs and lows of the energy sector. The latest energy downturn, coupled with the coronavirus pandemic, sent the city’s total vacancy rate to new heights.

By the end of the first quarter of 2021, roughly a third of all office space in Houston was available to lease. Brokers expect that percentage to start declining later this year, as real estate users begin to make decisions again.

Leasing activity is ticking up, suggesting that recovery isn’t far away, but lengthy deal transaction times, tenant interest in downsizing and expiring sublease space could send the vacancy rate even higher before it comes down again.

The first quarter of 2021 marked a year since the onset of the coronavirus pandemic. Over that year, a combination of bankruptcies, downsizings and layoffs caused available space to increase by 4.4% year-over-year to 54.8M SF, the equivalent of 31.6% of total inventory, according to JLL’s Q1 2021 market report.

While office brokers told Bisnow that leasing activity in Houston picked up in Q1, that activity did not necessarily make it into the quarterly numbers: Total vacancy rose for the fifth consecutive quarter and set a record high at 26.2%, JLL said.

Net absorption remained negative at 1M SF, with 15 of Houston’s 19 submarkets posting occupancy losses in Q1. Marketwide, leasing volume was 1.3M SF, which is 66% below the five-year quarterly average.

Transwestern Senior Vice President Tyler Garrett said that office leasing activity in Houston began to significantly increase in February, but transactions can take months to close, which is likely why the vacancy rate in Houston rose in Q1.

Coming out of downturns in the past, it has usually taken between six and 12 months for economic recovery to be reflected in usual office metrics like vacancy rates and absorption. The noticeable uptick in leasing-related activity suggests that the recovery period has begun, but Houston’s dismal vacancy rate still has some room to rise before coming down. 

“If we haven't plateaued, we're pretty close to it,” Garrett said. 

Sublease availability also rose during Q1, reaching 6.4M SF, JLL found. But Houston’s sublease volumes have remained much lower than other major U.S. markets during the pandemic, according to CBRE Senior Vice President Jessica Ochoa.

The energy downturn in late 2014 and 2015 flooded Houston’s office market with sublease space, as oil and gas firms rapidly downsized. Since then, most have been operating with a lean mindset and have kept their real estate footprints modest.

Ochoa said that some of the sublease space on the market, which is due to expire between now and the end of 2022, will have a difficult time getting leased because of its short-term nature. That space will likely convert to direct vacancy and push up Houston’s total vacancy rate further.

“The good news is, of that sublease space that's expiring between now and the end of 2022, it's a relatively small percentage of space. So overall, in all of the Houston inventory, it wouldn't be a dramatic increase,” Ochoa said.

The shift to remote work during the pandemic has forced many employers to reevaluate their need for physical office space. Now that vaccines are widely available in the U.S., many decision-makers are mulling whether to maintain or shrink their office footprints.

Cushman & Wakefield Executive Vice Chairman Tim Relyea said that in Houston, the majority of firms appear to be looking at downsizing in some way. That extends to the energy sector, which accounts for roughly 40% of office usage in Houston. 

Major global energy firms like ExxonMobil, Shell and Chevron tend to own their own campuses, and from a security standpoint, are unlikely to sublease space, but those that are leasing additional facilities off-campus may consider getting rid of that square footage, Relyea said.

“[It was] a little bit different when they were scattered and leased space. Now, some of them who have excess space and leased facilities, some of those spaces are probably at risk,” Relyea said.

Garrett said he hasn’t seen any material downsizing yet, though there have been a few cases where tenants have opted to give back between 10% and 15% of their office space. Balancing out that downsizing has been an emerging trend of office expansions, led primarily by firms in the professional services, finance and law fields.

“I would say net-net, we're seeing almost more expansion than we are downsizing,” Garrett said.

Relyea noted that he has also seen expansion activity from green technology firms looking to scale up. That trend is expected to continue, especially with the rise of startup incubator spaces like The Ion in Midtown and efforts by energy firms to develop their green technology offerings.

Vacancies, absorption and leasing activity have varied dramatically between submarkets over the past year, with areas such as Greenspoint, Westchase and the Energy Corridor taking some of the biggest hits. The Greenspoint/North Belt submarket, which has an inventory of about 8.8M SF, reached a total vacancy rate of 52.9% in Q1, JLL found — the highest vacancy rate of any submarket in Houston.

Ochoa said the central business district in Downtown Houston continued to be the most active submarket in Houston during Q1.

Over the past 12 months, the CBD had 1.6M SF of leasing activity, which was the highest in the city, Ochoa said. However, that volume is still well below normal. Between March 2019 and March 2020, the CBD recorded about 2.4M SF of leasing activity, according to CBRE. Its total vacancy sits at 25.5%, according to JLL.

Throughout the pandemic, many firms chose to sign short-term extensions of one to three years. As a result, many of those leases are expected to expire between 2022 and 2024. Many leasing deals are transacted 12 to 15 months ahead of expiration, meaning that tenant leasing activity is expected to ramp up soon.

“We're conglomerating a lot of lease roll into a shorter period of time. So that's going to obviously lead towards more activity,” Garrett said.

The brokers that spoke to Bisnow agreed that Houston’s citywide vacancy rate should come down within the next year, and the next few years are likely to showcase improvement, particularly amid the city’s projected population growth and economic recovery. 

Ochoa said that once Houston emerges from the economic double whammy of the pandemic and the energy downturn, she expects Houston’s vacancy rate to return to the high teens. However, the likelihood of ever returning to single-digit vacancy remains low, because Houston has a large stock of older office buildings that are becoming much harder to lease. 

“The flight to quality continues. And when we have a downturn in the economy, that gives Class-B tenants the opportunity to upgrade at a value. So it continues to suppress the B market,” Ochoa said.

Garrett said that because landlords are offering more and more concessions to tenants, he is also seeing some companies look at moving submarkets completely — a new trend that goes against typical submarket loyalty.

“It really places importance on making sure you're active in every submarket and knowing all the deal flow. Your pool of prospects is likely larger, because tenants are willing to move around,” Garrett said.

For all the speculation around future leasing activity, much still depends on the speed and efficacy of the vaccination rollout, and whether new variants could wreak further havoc on the economy and the workforce.

Relyea said that as long as the coronavirus doesn’t take another bad turn and more Americans get vaccinated, more companies should be back in the office by fall.

“I think it will really start to pick up, even more than it is picking up now,” Relyea said.