2016: A Wait-and-See Year In, Will they or won t they? has nothing to do with the Federal Reserve and interest rates and everything to do with OPEC s decision to potentially curb production. Observers are closely watching how OPEC's decision will impact the oil market and, in turn, affect the local economy. A lack of clarity is causing uncertainty, which is being felt throughout s office market. Economic Overview When thinking about s economy, three things are clear. First, the price of oil is not sustainable at current levels, which is evident by looking at the cash flows from publicly traded energy companies. Second, economies with oversized exposure to one segment are more prone to the ups and downs of a business cycle, but economic growth tends to outperform the U.S. average over a longer time period; this point is often lost during periods of weak growth. Third, the local economy has continued to produce positive, albeit, slower employment gains, following the downturn in the energy sector. Nonfarm payroll employment expanded by 16,400 jobs year-over-year through January 2016, which represented a 0.6% increase. This was a slower rate of growth than the 3.0% to 4.0% gains seen from 2012 to 2014, but the overall figure remains positive. What Does It All Mean? The office market is a lagging indicator of a lagging indicator, meaning office leasing cycles tend to follow corporate profits and employment trends. The most accurate leading indicators of the office market and economy are the sublease market and Purchasing Managers Index (PMI), respectively. The sublease market represents either future direct vacancy or space that has the potential to significantly impact the direct market, as competition for tenants heats up. The PMI Index is a short-term indicator on the direction of the economy, with a reading below 50 suggesting economic contraction; above 50, economic expansion. From this perspective, both indicators suggest a bleak near-term outlook. At the end of the first quarter of 2016, sublease space reached a new record high at 9.0 million square feet, up from 7.7 million square feet in fourth-quarter 2015. Contributing to the quarterly jump were Shell Oil Company, Marathon Oil, Apache Corporation, BHP Billiton and Technip, which added a combined 1.0 million square feet of sublease space during the quarter. Furthermore, the sublease market represents 4.5% of total inventory, the highest rate seen across major U.S. markets. Turning to the PMI Index, February marked the 14th consecutive month below 50, highlighting the short-term headwinds that exist in the local economy. The End Game With all signs pointing to a soft office market in 2016, it is useful to compare this downturn to what occurred in the 1980s. That decade represents a worst-case scenario that included a downturn in the energy sector, a banking crisis, a lack of capital, high interest rates and a saturated real estate market. For comparison, the similarities end at the downturn of the energy sector. Capital outside of construction financing remains available, and interest rates are historically low. Construction was more constrained in this cycle, with the added benefit of a healthy banking system and national economy. While the short term will be rough, the long-term outlook for the nation s fourth-largest metro provides some optimism. Current Conditions 3.0 2.0 1.0 0.0-1.0 The amount of available sublease space continues to rise. At the end of first quarter, more than 9.0 million square feet was being marketed up from roughly 7.7 million square feet at the end of 2015. Net absorption was in the red, with a negative 236,300 square feet absorbed in first quarter 2016. The overall vacancy rate stood at 17.7%. Market Analysis Asking Rent and Vacancy $30 $28 $26 $24 $22 $20 10% 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 Net Absorption Square Feet, Millions -2.0 1Q11 1Q12 1Q13 1Q14 1Q15 1Q16 Market Summary Average Asking Rent (Price/SF) Vacancy (%) Current Quarter Prior Quarter Year Ago Period 20% 18% 16% 1 12% 12 Month Forecast Total Inventory (SF) 199.9 M 199.0 M 193.5 M Vacancy Rate 17.7% 17.6% 15.1% Net Absorption (SF) -236,300 639,247-1,695,738 Average Asking Rent $28.75 $28.72 $28.29 Under Construction 5,260,162 4,891,651 10,568,470 Deliveries 0 3,482,837 1,659,795
Asking Rents Remained Stable Turning to pricing, average asking rents remained stable at $28.75/SF at the end of the first quarter. This figure was similar to fourth-quarter 2015 and was up 1.6% year-over-year. Most landlords have chosen to hold tight on face rents, but have become more generous with tenant improvement and rent abatement packages. By segment, Class A rents also remained basically unchanged at $34.69/SF in first-quarter 2016, compared with $34.64/SF in the previous quarter. Meanwhile, Class B showed a small quarterly decline to $20.91/SF. The nearly $14 spread between Class A and Class B asking rents was near a decade high and is a bit unusual, considering the amount of Class A product either vacant or available for sublease. It is safe to assume the spread contracts when based on effective rents. Absorption Sluggish Following two consecutive quarters of positive absorption, demand weakened, as more than 236,000 square feet of negative absorption was recorded in first-quarter 2016. As a result, vacancy increased by 10 basis points, to settle at 17.7%. Despite this increase, several notable transactions took place in the first quarter. Hines landed its second major tenant for its speculative development taking place at 609 Main Street, as United Airlines committed to 225,000 square feet. This transaction followed the 62,000-square-foot lease signed by Kirkland & Ellis. Down the street, alternative investment firm Angelo, Gordon & Co. leased nearly 11,500 square feet at 712 Main Street. In the Energy Corridor, BASF Corporation leased the top four floors in Energy Tower IV. This lease represents nearly 110,000 square feet and brought the occupancy up to 60% in the newly completed building. Deals continue to take place, but leasing velocity remains lackluster. Submarket Spotlight CBD Downtown has been experiencing an exciting renaissance. A growing number of s residents and visitors are seeing Downtown as a place to do far more than work. Since its revitalization began in the mid-1990s, more than $6.1 billion of buildings, parks and infrastructure have been completed. continues to welcome businesses relocating to the Central Business District, where 1.2 million square feet of office space is currently under construction, as well as nine new and modern multihousing complexes representing 2,667 units. Another economic catalyst for Downtown growth has been s urban parks, Discovery Green and Market Square Park. Downtown's premier green space, the 12-acre Discovery Green is known as "Downtown's new backyard." Market Square Park is at long last being reclaimed as the bustling center of Downtown s Historic District. Downtown can easily be considered its own energy hub, as it is home to some of the largest oil, gas, trading and banking companies in the country. Roughly 47% of tenants Downtown are tied to the energy sector. Lower oil prices have caused vacancies to rise and increasing amounts of sublease space to come onto the market. During the first quarter, Shell Oil Company made 350,000 square feet of contiguous space available for sublease at 910 Louisiana Street. As a result, total available space in the CBD stands at 25.1%. Despite the current softness, Downtown remains an attractive place to work. Take, for example, the speculative development underway at 609 Main Street. This project, which is being developed by Hines, represents a 48-story Trophy office tower with more than 1 million square feet and has landed two major tenants. Furthermore, a growing urban population and ongoing construction activity has positioned Downtown as a place to live, work and play. Lease/User Transactions Tenant Building Submarket Type Square Feet Bureau Veritas Greenspoint Park II Greenspoint Direct 43,600 Pattern Energy Group Total Plaza CBD Direct 34,901 Common Resources Town Center II Woodlands Direct 24,353 Catholic Charities of the Americas 2707 N Loop W North Loop West Direct 21,079 Angelo, Gordon & Co. 712 Main Street CBD Direct 11,477 Select Sales Transactions Building Submarket Sale Price Price/SF Square Feet Equus Office Portfolio $60,000,000 $198.31 302,562 Great Southwest Building * CBD $10,250,000 $68.33 150,000 5433 Westheimer Road * Galleria/Uptown $13,125,000 $98.68 133,000 The Bar Center CBD undisclosed - 92,883 Northwest Central I * Far Northwest $2,020,000 $35.93 56,228 * Approximate price. 2
www.ngkf.com Submarket Statistics Total Under Total Qtr YTD Direct Sublet Average Total reflects Class A,B,C Inventory Construction Vacancy Absorption Absorption Asking Rent Asking Rent Asking Rent (SF) (SF) Rate (SF) (SF) (Price/SF) (Price/SF) (Price/SF) CBD Total 38,094,280 1,171,658 17. -45,358-45,358 $41.70 $30.34 $40.37 Class A 27,042,612 1,171,658 12.8% 23,499 23,499 $45.58 $32.78 $44.02 Class B 10,132,307 0 27.2% -75,457-75,457 $29.58 $24.81 $29.18 Allen Pkwy/Montrose Total 5,231,220 0 15.3% -419-419 $32.34 $26.21 $32.14 Class A 1,853,042 0 30.2% 15,251 15,251 $34.09 $27.08 $33.94 Class B 2,772,019 0 6.6% -17,397-17,397 $30.18 $26.73 $30.02 Bellaire/Medical Ctr Total 5,129,989 0 9. -27,881-27,881 $22.77 $23.13 $22.82 Class A 1,091,536 0 9.0% 16,413 16,413 $27.11 $15.30 $25.04 Class B 3,065,714 0 9.6% -45,581-45,581 $22.23 $26.73 $22.80 Clear Lake/SE Hou Total 6,850,655 0 17.5% -30,774-30,774 $18.52 $26.06 $18.78 Class A 1,785,952 0 8.8% -62,627-62,627 $24.66 $30.06 $25.61 Class B 4,155,454 0 22.2% 36,162 36,162 $17.88 $19.00 $17.89 Conroe/Mont Co Total 1,018,526 0 19.8% -2,520-2,520 $23.21 - $23.21 Class A 253,161 0 62.5% - - $24.53 - $24.53 Class B 527,899 0 7.1% -2,520-2,520 $22.75 - $22.75 East/Pasadena/Baytown Total 4,457,319 129,105 17.2% -6,718-6,718 $20.32 $18.72 $20.25 Class A 22,706 0 13.7% - - $30.59 - $30.59 Class B 2,757,064 129,105 20.0% 11,691 11,691 $20.31 $18.72 $20.21 Energy Corridor Total 18,832,955 952,893 22.5% -41,887-41,887 $31.27 $21.53 $30.23 Class A 12,405,449 952,893 22.3% -21,437-21,437 $35.31 $24.69 $34.52 Class B 6,028,366 0 24.0% -17,761-17,761 $24.13 $19.15 $23.31 FM 1960 Hwy 249 Total 7,360,158 0 18. -46,787-46,787 $19.43 $14.98 $19.01 Class A 2,312,525 0 15.9% -8,196-8,196 $26.80 $23.91 $26.55 Class B 4,461,781 0 20.9% -39,512-39,512 $17.45 $12.60 $16.94 Galleria/Uptown Total 22,589,756 1,285,000 12.9% 97,461 97,461 $35.45 $29.32 $35.11 Class A 16,556,047 1,285,000 13. -14,423-14,423 $37.90 $30.02 $37.12 Class B 5,938,709 0 11.7% 111,884 111,884 $25.96 $25.57 $26.42 Greenspoint/IAH Total 11,696,518 0 35. -41,234-41,234 $21.25 $14.91 $20.71 Class A 5,121,536 0 40.6% -55,084-55,084 $26.08 $15.38 $24.87 Class B 5,139,109 0 34. 5,055 5,055 $16.24 $13.70 $16.08 Greenway Plaza Total 10,548,120 398,696 13.0% 207,283 207,283 $34.04 $24.07 $33.89 Class A 6,949,625 398,696 14.9% 204,806 204,806 $37.01 $24.88 $36.86 Class B 3,018,309 0 8.8% 4,764 4,764 $27.15 $22.73 $27.05 3
www.ngkf.com Submarket Statistics Total Under Total Qtr YTD Direct Sublet Average Total reflects Class A,B,C Inventory Construction Vacancy Absorption Absorption Asking Rent Asking Rent Asking Rent (SF) (SF) Rate (SF) (SF) (Price/SF) (Price/SF) (Price/SF) Katy Freeway Total 12,927,227 226,511 13.6% -9,301-9,301 $28.23 $23.38 $27.39 Class A 5,864,647 226,511 15.7% 8,262 8,262 $37.92 $31.01 $36.55 Class B 6,333,786 0 13. -15,359-15,359 $22.64 $17.48 $21.68 Katy/Grand Pkwy Total 1,809,406 168,896 19.3% 7,427 7,427 $27.66 $24.56 $27.53 Class A 1,217,213 124,017 28.0% 14,527 14,527 $27.21 $24.56 $27.08 Class B 401,689 44,879 2.2% -7,100-7,100 $31.61 - $31.61 Kingwood/Humble Total 1,025,914 0 11.5% 22,032 22,032 $21.10 $10.80 $20.42 Class A 54,312 0 0.0% - - - - - Class B 828,102 0 12.5% 22,032 22,032 $21.51 $10.80 $20.73 Northwest Total 7,688,601 0 20.6% -97,333-97,333 $19.78 $17.18 $19.71 Class A 1,993,614 0 34.2% -77,221-77,221 $22.99 $18.51 $22.81 Class B 4,356,307 0 18.5% -15,693-15,693 $17.94 $13.98 $17.89 South Hou/SW Frwy Total 10,026,823 0 16.5% -6,205-6,205 $16.29 $16.77 $16.30 Class A 1,826,901 0 13.2% 809 809 $18.62 $17.09 $18.52 Class B 6,316,775 0 19.1% -17,901-17,901 $16.15 $15.00 $16.15 Sugar Land/E Ft Bend Total 6,447,311 40,000 11.3% 32,831 32,831 $25.36 $20.02 $24.62 Class A 3,488,926 0 10.6% 22,640 22,640 $27.99 $19.94 $26.28 Class B 2,683,667 40,000 12.6% 10,191 10,191 $22.90 $20.51 $22.79 West Belt Total 5,021,594 0 22. 8,341 8,341 $27.66 $24.17 $27.34 Class A 3,328,301 0 25.0% 12,465 12,465 $31.32 $24.64 $30.40 Class B 1,605,664 0 18.3% -4,124-4,124 $21.07 $15.00 $20.94 Westchase Total 14,357,827 445,000 17.5% -311,319-311,319 $31.56 $31.60 $31.73 Class A 8,166,310 445,000 20. -255,005-255,005 $38.11 $32.64 $36.68 Class B 5,977,054 0 13.1% -57,108-57,108 $20.18 $15.92 $19.94 The Woodlands Total 8,772,990 442,403 16.2% 56,061 56,061 $31.30 $28.97 $30.79 Class A 4,830,087 442,403 18.8% 36,926 36,926 $35.93 $32.86 $35.04 Class B 3,577,631 0 13.8% 43,254 43,254 $24.31 $19.60 $23.36 Suburban Total 161,792,909 4,088,504 17.7% -190,942-190,942 $27.50 $23.12 $27.14 Class A 79,121,890 3,874,520 19.5% -161,894-161,894 $33.92 $26.38 $33.10 Class B 69,945,099 213,984 17.1% 4,977 4,977 $21.36 $18.14 $21.12 Market Total 199,887,189 5,260,162 17.7% -236,300-236,300 $29.09 $25.64 $28.75 Class A 106,164,502 5,046,178 17.8% -138,395-138,395 $35.58 $28.54 $34.69 Class B 80,077,406 213,984 18. -70,480-70,480 $21.08 $19.28 $20.91 4
Economic and Office Construction Conditions Texas Development Activity Top 10 Submarkets by Square Feet Under Construction Rank Submarket (SF) 1 Dallas Far North 2,728,058 2 Galleria/Uptown/West Loop 1,285,000 3 CBD 1,171,658 4 Dallas Uptown/Turtle Creek 1,001,330 5 Energy Corridor 952,893 6 Austin CBD 680,358 7 Dallas Las Colinas 542,183 8 Westchase 445,000 9 The Woodlands 442,403 10 Dallas Richardson/Plano 411,258 Employment By Industry, 2015 Annual Data 16% 21% 13% 1% 3% 5% 12% 7% 10% 8% Information Mining and Logging Other Services Financial Activities Construction Manufacturing Leisure and Hospitality Education and Health Services Government Professional and Business Services Source: Newmark Grubb Knight Frank Unemployment Rate Payroll Employment Not Seasonally Adjusted 10% 8% 6% 2% 0% Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Total Nonfarm, Not Seasonally Adjusted, 12-Month % Change 5% 3% 2% 1% 0% Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 United States United States Consumer Price Index (CPI) Employment Growth by Industry All Items, 12-Month % Change, Not Seasonally Adjusted, 1982-84=100 8% 6% 2% 0% -2% Feb-11 Feb-12 Feb-13 Feb-14 Feb-15 Feb-16 United States, January 2016, 12-Month % Change, Not Seasonally Adjusted Total Nonfarm Mining and Logging Construction Manufacturing Trade, Transportation, and Utilities Information Financial Activities Professional and Business Services Education and Health Services Leisure and Hospitality Other Services Government -20.0% -15.0% -10.0% -5.0% 0.0% 5.0% 10.0% 5
1700 Post Oak Blvd 2 BLVD Place, Suite 350, TX 77056 713.626.888 Newmark Grubb Knight Frank United States Office Locations David Wegman, CFA Director of - Texas 713.599.5151 dwegman@ngkf.com Leta Wauson Manager - Texas 713.599.5108 lwauson@ngkf.com Newmark Grubb Knight Frank has implemented a proprietary database and our tracking methodology has been revised. With this expansion and refinement in our data, there may be adjustments in historical statistics including availability, asking rents, absorption and effective rents. Newmark Grubb Knight Frank Reports are also available at www.ngkf.com/research All information contained in this publication is derived from sources that are deemed to be reliable. However, Newmark Grubb Knight Frank (NGKF) has not verified any such information, and the same constitutes the statements and representations only of the source thereof, and not of NGKF. Any recipient of this publication should independently verify such information and all other information that may be material to any decision that recipient may make in response to this publication, and should consult with professionals of the recipient s choice with regard to all aspects of that decision, including its legal, financial, and tax aspects and implications. Any recipient of this publication may not, without the prior written approval of NGKF, distribute, disseminate, publish, transmit, copy, broadcast, upload, download, or in any other way reproduce this publication or any of the information it contains.