Office Tours Canceled, Deal-Making Slows In Houston

As Houston’s economy attempts to weather the effects of the coronavirus outbreak and tumbling crude oil prices, commercial real estate professionals in the office market are bracing for minimal deal-making in the coming weeks and months.

“I think there's going to be a lot of damage inflicted on the market this year, and it's probably going to start occurring now through the third quarter,” Transwestern Senior Vice President Tyler Garrett told Bisnow.

The coronavirus, which causes the disease COVID-19, has been wreaking havoc on the global economy since the beginning of the year, with consumer spending and income hurt by consumers staying home and some businesses temporarily closing to limit the virus’s spread. 

The U.S. federal government recommended Monday that people gather in groups of no more than 10 people. Houston’s city and county officials on Monday also ordered all bars and clubs to close their doors for 15 days. Restaurants can only provide pickup, delivery and drive-thru services.

Additionally, an ongoing price war between Saudi Arabia and Russia has led to plummeting oil prices, which negatively impacts Houston’s economy and office market. West Texas Intermediate dropped to $20.37 per barrel on Wednesday, the lowest price seen since February 2002.

To mitigate recent economic volatility, the U.S. Federal Reserve slashed the federal funds rate to between 0% and 0.25% on Sunday, a historic low last seen during the 2008 financial crisis. It was the second rate cut this month, after the Fed previously lowered the rate on March 3.

As businesses have scrambled to adapt to rapidly changing measures, many of Houston’s commercial real estate firms have had business deals placed on hold.

"I've had multiple tours canceled,” Lee & Associates principal Robert LaCoure said. “I've now had three deals in the last two days be put on hold. If not indefinitely, at least throughout the end of the year, some of them are saying, until they figure out what's going on."

LaCoure told Bisnow each deal involved a different type of firm: an upstream oil and gas company, a travel-related company and an IT company that services the energy industry.

In the case of the oil and gas company, LaCoure said he even had a signed lease and check on his desk, but he was asked to hold off giving those to the landlord so the company could reassess.

The cancellation of office tours and delays in deal-making started to intensify over the weekend and has extended into this week, LaCoure noted.

Colliers International Houston President Patrick Duffy said that while some deals are still getting done, things began to slow down over the weekend as the market hit something of an inflection point.

“We've got clients that are continuing to push forward, and we're getting deals done. We've also had more than a few say, 'We need to postpone closing for a month while we sort all this out,'” Duffy said.

He added that Colliers International is sending around contract extensions to ensure that the firm is not out of contract.

“Anybody with time flexibility, we're just trying to get all parties to agree, this is an unusual time, let's keep everything together and give it a week or two, and then try to get it back on track,” Duffy said. 

Transwestern has seen numerous cancellations of Houston office tours. Garrett said those tours will be rescheduled once the situation becomes more normalized.

“There still are a few, but as of the last 24-48 hours, I think that's going to come to a screeching halt here, at least until schools reopen and that sort of thing,” Garrett said.

Although Transwestern hasn’t seen any deals fall through at this stage, Garrett said some have slowed down from what would typically be a more aggressive time frame.

“If somebody doesn't have a need that is driven by a near-term expiration, then they are more likely to delay things,” he said.

The outlook for Houston’s office market in the second quarter has become increasingly grim.

“I'm expecting it to be zero absorption, and companies that have leases that are expiring will probably go month-to-month, and sit and wait and be willing to pay that to avoid risking long-term obligations,” LaCoure said.

Lee & Associates handles office leasing for 11 buildings in Houston. LaCoure said he expects all of those buildings to feel the twofold impact of COVID-19 and low oil prices.

“In a time where you don't know where your next deal is going to come from, or when it's going to come around, you've got to think outside the box and be willing to do a deal today that's really buying occupancy for tomorrow and bet on the future,” he said.

Garrett said that while landlords with high-quality buildings would be fine, the lower-tier Class-B and Class-C buildings could struggle.

“I think you are going to see prolonged vacancy in that commoditized product, and I just don't see any other way around that at the moment,” Garrett said.

At the higher end of the spectrum, the pricing for Class-A new construction had soared prior to the coronavirus outbreak, moving considerably higher than existing top-tier, Class-A buildings. 

“The question in the market is, will tenants continue with that flight-to-quality trend, knowing that the delta and the rents that they're paying and the deal they're getting compared with what they could get elsewhere is growing?” Garrett said.

He also noted that, in the short term, there may be downward pressure on construction pricing, but it hardly matters, as nobody is likely to start building right now.

“What this will do is curb any new construction unless it's preleased or build-to-suit, in Houston at least,” Garrett said.

Avison Young principal Charlie Neuhaus said that while the coronavirus outbreak would eventually ease off, he was more concerned about the damage that low oil prices could do to the office market.

“For me, the price of oil poses a way bigger threat to the city of Houston economy and real estate versus the coronavirus,” Neuhaus said. “I don't think Houston can handle $30 or $35 oil long term. If it sticks around, we're certainly going to see reduction, and we'll certainly see landlords continue to fight for occupancy.

"If we have $30 oil through the end of Q2, we're still looking at another two quarters of trying to rebalance and get everything back started.”

Upstream oil and gas firms specializing in exploration and production activities are expected to take the biggest hit from low oil prices this year. Without the ability to make any profit, many small and midsized E&P companies could instead be facing acquisitions or bankruptcies. 

“We're going to see a wave of bankruptcies — both reorgs, Chapter 11 and full liquidations, Chapter 7. That's unavoidable at this point. A lot of these companies were living on debt and not cash flowing very well when oil was in the low $50s,” Duffy said.

“The office market, especially as it relates to the energy sector, is going to get hit pretty hard in the next quarter or two, depending on how long all this lasts,” he added.

Despite the gloom, there could be an upside to the situation.

Neuhaus said that right now, there is a huge movement to work from home, which could have a permanent influence on how the commercial real estate industry does business.

“While face-to-face is great, we're way more efficient if we don't have to spend time in our cars driving from meeting to meeting versus just working over videoconference,” Neuhaus said.

“For the most part, we've got deals working in Houston and across the country, and so far, [working] from home has been just as effective as being at the office,” he added.