Two quarters into 2016 and we have already seen a turbulent year, with January and February lows replaced by some rebalancing in March and April, only for volatility to return at the end of the second quarter with Brexit. While Q1 2016 was likely the bottom of the oil commodity downturn, we have again in recent weeks seen WTI prices fall. This is likely a short-term result of Brexit and the value of the dollar, but nonetheless presents further concern for local and national economies. Projected U.S. GDP for 2016 has now been revised down from 2.4% to 1.8%, with the latest revision for Q1 at 1.1%. Consumer spending and consumer credit remain strong points, fueling about two-thirds of GDP. Recent changes in national employment further underscore the volatility of the first half of the year, dropping to only 11,000 new jobs in May and then bouncing back to 287,000 new jobs in June. Brexit will likely have minimal effects on the U.S., and the world as a whole, as the United Kingdom only accounts for about 4% of global GDP. Yet, Brexit could actually catalyze U.S. commercial real estate investors to remain in the U.S. rather than Central London, where many have previously sought opportunities. The economic outlook for Texas and Houston economies is uncertain, sitting on the edge of further declines or mild to modest growth for the remainder of 2016.
At 754,000 sq. ft. and 3.7 million sq. ft., respectively, both net absorption and leasing activity experienced significant declines in Q2 2016 compared with historic Q2 performance. Availability in Q2 was 9.3%, an increase of 3% QoQ and 26% YoY. Vacancy for all industrial space combined was 5.4%, an increase of 5.9% QoQ and 20% YoY. With a surge in manufacturing sublease space, manufacturing availability has increased to 7.9%, substantially greater than its historic average of 4.6%. Vacancy and availability of warehouse/distribution space has also increased, but both are still near their historic range of performance. Deliveries of 2.6 million sq. ft. represents an increase of 16% QoQ and 23% YoY. Current under construction space amounts to 12.3 million sq. ft., much of which is accounted for by one 4.0 million sq. ft. development by Daikin. Warehouse and distribution products, particularly those that are rail served, remain in high demand.
The overall economic outlook has again declined for Texas and Houston, despite some intermittent positive signs. Brexit has increased volatility in financial markets, but could lead to increased CRE spending in U.S. as investors shift from Central London. The oil and gas downturn is now manifesting throughout Houston beyond just those direct businesses. The hopes are that the oil industry will swing back up before the national economy slows, which remains solid despite some mixed numbers and slowdowns.
Economic data in recent weeks and months are sending mixed messages for second quarter performance, leading many to further debate whether the economic expansion will continue or reverse course and slide downward. The Leading Economic Index (LEI) declined by a slight 0.2% in May — its third drop in six months — but overall this looks to be short lived. The U.S. gross domestic product (GDP) is now projected to be 1.8% for 2016, a modest decrease from 2.4% in 2015. GDP was revised up to 1.1% for Q1 2016, and is expected to come in around 2.4% for Q2. Strong consumer spending, which accounts for about two-thirds of GDP, will continue to fuel economic growth. Consumer credit further strengthened in May, and strong consumption in April and May will likely account for growth in Q2 2016. Consumer confidence increased 7.6 points in June, though some concern remains in the job market. International trade will continue to decline and hamper GDP with the strong dollar (up nearly 20%). Greater import growth in May led to a wider trade deficit, which is likely to increase by 4% in 2016, following 6.2% increase in 2015.
At the center of the mixed messages in economic data are numbers on employment. Job growth in May dropped to only 11,000, but bounced back higher than expected to 287,000 new jobs in June, resulting in a three-month trend of 147,000 new jobs. With the unemployment rate remaining below 5%, the labor market continues to tighten. However, recent growth in jobs has been in industries with high and low wages, leaving middle-class wages to lag.
After a few months of growth and modest stability following lows in January and February, volatility has again returned to the financial and commodity markets, largely as a timely result of Brexit. Since the vote for the U.K. to leave the European Union, global financial markets have settled down. Effects on the U.S. will likely be minimal over the long term, but uncertainty will continue as the UK and EU begin working out negotiations on their future economic relationships. The U.K. will likely dip into a mild recession later in 2016, but this should not have a large effect on world economics, as the U.K. only represents 4% of global GDP. With uncertainty in the U.K., investors in commercial real estate from the U.S. may shift from Central London and simply remain in the U.S. with its strong CRE industry. To wit, the Dodge Momentum Index, a 12-month leading indicator of non-residential construction spending, jumped 11.2 percent in June and overall in Q2.
The ISM non-manufacturing index increased in June to 56.5, indicating that the economy continues to expand at a moderate pace. Moreover, the NFIB Small Business Optimism Index increased in June for the third month in a row. The ISM manufacturing index indicated that in June factories grew at the strongest rate since early 2015, but growth will remain modest in months to come, as shipments, orders and inventories are still declining, though at a slower rate. Given a variety of headwinds, including low May job growth, financial volatility, and reduced manufacturing, the current speculation is for only one remaining interest rate hike by the Federal Reserve Bank, likely after the presidential election.
The housing market is yet another variable producing mixed economic signals. Both the good-time-to-buy and good-time-to-sell indices increased in June, but the Home Purchase Sentiment Index dropped to 83.2. The high value of the dollar has led the National Association of Realtors to point out that home values by international buyers have decreased by 1.3%. This is leading such buyers to seek out lower-priced homes. Sales of new homes decreased by 6% in May.
Houston and Texas Economy
Following the lows in oil prices of Q1, the initial months of Q2 saw prices swing up as global inventory stock piles slowed. Then Brexit and the value of the dollar saw oil prices decline again, restarting a new set of price swings and volatility in recent weeks. Due to weakness in the energy market, banks of the Eleventh Federal Reserve District have increased their funds set aside in case of loan losses, supporting recent increases in noncurrent loans associated with oil and gas companies.
Overall, Texas and Houston have a mixed set of economic numbers. Employment in Texas, despite the energy pullback, grew 0.4% in May compared to U.S. at 0.3%, with 4,400 new jobs following 14,500 new jobs in April. Unemployment in Texas remains at 4.4%, still lower than the national level of 4.7%. To this end, the Texas Leading Index, which uses key economic indicators to forecast future employment growth, did increase across sectors, suggesting some improvements ahead. Texas retail sales previously declined, but increased modestly in June as evidenced by the Texas Retail Outlook Survey. While employment growth in Houston contracted by 1.9% from April to May—with job growth coming from government, and education and health services—Houston’s unemployment rate dropped to 5% in May. Layoffs in Houston are now trickling through the economy and manifesting in residential, retail, wages, and office markets. Housing remains strong in other cities and regions of Texas, but Houston’s housing market has weakened substantially.
Total net absorption for all industrial products combined in Q2 2016 was 754,862 sq. ft., representing a 27% QoQ increase in demand, but a decrease of -70% YoY. With the pullback in the oil industry, Q2’s net absorption was a significant decrease from the quarter’s historic performance. Likewise, quarterly leasing activity of 3.7 million sq. ft. was significantly lower than historic Q2 performance. However, warehouse and distribution products, particularly those that are rail-served on the east side of Houston, remain in high demand. Declines in manufacturing continue at both local and national levels. Availability in Q2 2016 was 9.3%, an increase of 3% QoQ and 26% YoY. Vacancy increased to 5.4%, a 20% increase YoY. Vacancy for flex, manufacturing, and warehouse/distribution space were 6.8%, 2.0%, and 6.1%, respectively — each of these figures are lower than their historic Q2 averages. However, with increases in subleases, the availability for manufacturing space at a high 7.9% has increased significantly above its historic Q2 performance. Deliveries in Q1 were about 2.6 million sq. ft., with 12.3 million sq. ft. under construction.
Net absorption, a key metric for demand of industrial space, measures the change in occupied inventory, including direct and sublet space. Total net absorption for all products combined in Q2 2016 was 754,862 sq. ft., yielding an increase of 27% QoQ but a decrease of -70% YoY (Table 1, Fig 2A). The historic Q2 average (± 95% confidence interval) for net absorption is 1,612,700 sq. ft. (± 989,578). We are 95% certain that Q2 net absorption typically falls between 623,153 and 2,602,248 sq. ft. With the pullback in oil and associated impacts on the industrial market, net absorption in Q2 2016 was substantially lower than average Q2 performance, but did not deviate significantly from historic Q2 levels since 2000.
Figure 2B breaks total net absorption down since 2005 by year and quarter for three product types: flex, manufacturing, and warehouse/distribution space. Warehouse/distribution and flex saw modest increases of net absorption in Q2 2016, but manufacturing net absorption declined (Figure 2B).
A measure of demand that is more forward looking than net absorption is leasing activity, the total amount of space represented by direct leases, subleases, renewals, and pre-leasing. Figure 3A reports all leasing activity since 2000, while Figure 3B breaks down leasing activity by year and quarter for each of flex, manufacturing, and warehouse/distribution space. Leasing activity of 3.7 million sq. ft. occurred in Q2 2016, marking decreases of -26% QoQ and -70% YoY (Table 1). The historic Q2 average (± 95% confidence interval) for leasing activity is 5,704,580 sq. ft. (± 875,003). We are 95% certain that Q2 leasing activity typically falls between 4,829,577 and 6,579,583 sq. ft., indicating that leasing activity in Q2 was significantly lower than its historic Q2 performance since 2000. Notably, however, manufacturing leasing activity increased from 55,000 sq. ft. to 279,000 sq. ft., with flex and warehouse/distribution accounting for the overall decline.Figure 3A and 3B
Vacancy and Availability
Vacancy and availability measure the supply of industrial space. Availability estimates total supply because it includes vacant, occupied, and sublease space. Vacancy estimates empty space on the market, whether or not that space is leased or for rent. Supply continues to remain low, but with some key increases in recent quarters (Tables 1 and 2, Figure 4). For all industrial buildings combined, availability in Q2 2016 was 9.3%, an increase of 3% QoQ and 26% YoY (Table 1). Likewise, vacancy for all industrial space combined was 5.4%, an increase of 6% QoQ and 20% YoY (Table 1).
Figure 4 shows percent availability and vacancy for flex, manufacturing, and warehouse/distribution buildings since 2000. Table 2 summarizes availability and vacancy of flex, manufacturing, and warehouse/distribution buildings for Q2 2016. In particular, note that vacancy and availability of flex space remain below historic levels. However, with the surge of sublease space, availability of manufacturing space at 7.9% is significantly greater than its historic average of 4.6%. Nonetheless, the vacancy measure for manufacturing has yet to see the increase exhibited by the availability measure, and remains at a low 2%. As for warehouse/distribution space, both vacancy and availability are increasing, but still within their historic ranges of performance.
Figure 5 plots asking rent prices since 2000 for flex, manufacturing, and warehouse/distribution space. In Q2 2016, flex space continued to show its declining asking rents of recent quarters, while manufacturing and warehouse/distribution seem to have stabilized.
Construction of new buildings is an important variable determining the supply of industrial space. “RBA Delivered” refers to completed construction, while “RBA Construction” refers to space under construction that has not yet been completed. As detailed in Table 1 and Figure 6, deliveries in Q2 2016 were 2.59 million sq. ft., an increase of 16% QoQ and 23% YoY (Table 1). RBA under construction was 12.3 million sq. ft. in Q2 2016, a decrease of -9.2% QoQ -16.8% YoY (Table 1). Of this 12.3 million under construction, ~4.0 million is accounted for by Daikin Industries’ new campus in Waller, Texas. Figure 6a and 6b
Figure 7 depicts changes in the inventory of flex, manufacturing, and warehouse/distribution space since 2000, both for RBA and number of buildings. RBA inventory for all industrial space increased to 566 million sq. ft. for 18,508 buildings, which is an increase of 0.3% QoQ and 1.0% YoY (Table 1).