Houston Office market ends year with absorption in the black for first time since 2019

EXECUTIVE SUMMARY

Q4 In Review
By the end of Q4 2023, the overall vacancy rate in the Houston office market rose 30 basis points year-over-year, from 24.6% to 24.9%. Net absorption increased to 1.4 million sq. ft., improving from the previous year’s -925,910 sq. ft. Class A space accounted for 87% (1.3 million sq. ft.) of the quarter’s positive net absorption—emphasizing “flight-to-quality” in Houston’s office market. Axiom Space secured the largest move-in for the year, occupying a 400,000-sq.-ft. building at 13200 Space Center Boulevard in December. Year-to-date, net absorption is at 723,438 sq. ft. Leasing activity is at 2.5 million sq. ft., down 41% from 4.2 million sq. ft. last year. Downsizing continued through the fourth quarter—NRG Energy reduced their footprint by 186,000 sq. ft., inking a deal for 245,000 sq. ft. of office space at 1301 McKinney Street in October. Lastly, the average asking rent (FSG) reached $30.42 per sq. ft.—a record-high for the metro’s office sector.

Houston Economic Update
Houston’s unemployment rate decreased to 4.4% in October 2023, slightly down from 4.7% in September 2023, according to the latest release of Houston’s Economic Indicators. The metro’s jobless rate beat the state and the national rates at 4.1% and 3.9%, respectively. Houston’s employment reached 3.4 million in October 2023—growing an annualized 3.7% (30,474 jobs) in the three months ending in October. The largest job gains by sector included: leisure and hospitality (+8,899 jobs, 10.3%), government (+9,578 jobs, 9%), information and other services (+3,529 jobs, 9.2%). The largest job declines by sector included: construction (-4,417 jobs, -7.5%), professional and business services(-13,502 jobs, -2.4%), and oil and gas(-1,193 jobs, -1.7%).

HOUSTON OFFICE MARKET OVERVIEW

Positive Net Absorption in Q4 2023
Net absorption—move-ins minus move-outs—is at 1.4 million sq. ft., improving year-over-year from -925,910 sq. ft. Year-to-date, net absorption is at 723,898 sq. ft., up from the prior year-to-date number of -1.1 million sq. ft. Class A space accounted for 87% (1.3 million sq. ft.) of the quarter’s positive absorption—emphasizing “flight-to-quality” in Houston’s office market. Axiom Space occupied a 4-story, 400,000-sq.-ft. office building at 13200 Space Center Boulevard in December 2023—securing the largest move-in of the quarter and the year. This is Axiom Space’s second move-in—(106,000 sq. ft. in May 2023) —expanding their Houston office presence to 506,000 sq. ft.

Leasing Down 41% Year-Over-Year
Quarterly leasing velocity—comprised of new leases and renewals—stood at 2.5 million sq. ft.— down 41% from 4.2 million sq. ft. in Q4 2022. Year-to-date, leasing activity is at 13.0 million sq. ft., compared to the prior year-to-date tally of 16.9 million sq. ft. By year-end, 77 leases were signed, averaging 54,828 square feet, with notable exceptions in May 2023 by LyondellBasell Industries (318,504 sq. ft.) and Fluor Corporation (308,186 sq. ft.). Tenant preference for smaller, high-quality space contributed to the slowdown in leasing activity throughout 2023. Downsizing continued in the fourth quarter; NRG Energy signed a 245,000-sq.-ft. office lease for Class A space —a 186,000-sq.-ft. reduction— at 1301 McKinney Street (3 Houston Center) in Q4 2023. NRG’s anticipated move-in date is January 2026.

Vacancy Rate at 24.9%
The overall vacancy rate in Houston’s office market is 24.9%. Quarter-over-quarter, the vacancy rate decreased 20 basis points from 25.1%. Year-over-year, the vacancy rate increased 30 basis points from 24.6%. Class A and Class B properties have vacancy rates of 26.2% and 25.4%, respectively. Class A submarkets with the greatest year-over-year increases in vacancy rates include: Gulf Freeway/Pasadena (21.8% to 33.0%), Medical Center (18.5% to 22.3%), and Katy Freeway (7.3% to 9.9%). Class B submarkets with the greatest year-over-year increases include: West Belt (24.1% to 32.4%), Southwest (16.7% to 23.9%), and Midtown (13.3% to 16.8%).

Deliveries Surpass 1 Million Sq. Ft.
By the end of Q4 2023, deliveries in the Houston office market had increased to 1.3 million sq. ft., surging year-over-year from 22,329 sq. ft. This marks the first time in two years that deliveries surpassed 1 million sq. ft. (1.7 million sq. ft. in Q4 2021). Year-to-date, deliveries are at 2.1 million sq. ft.—with the Katy Freeway and the South Main/Medical Center submarkets accounting for 66% of the space delivered. Dynamic One at TMC Helix Park—a 350,000-sq.-ft. office building—built in October 2023 at 1840 Dynamic Way (South Main/Medical Center submarket) accounted for the largest delivery of the year. Office construction is at 1.4 million sq. ft. across 10 buildings, with 375,581 sq. ft. (26%) available for lease. Over the prior three years, construction averaged 3.6 million sq. ft. annually.

Investment Sales Trends
CoStar Capital Market Analytics reports the cumulative 12-month sales volume for Q4 2023 at $322 million, down 86% from $1.1 billion in Q4 2022. By year-end, 673 deals were completed in the Houston office market with an average transaction price of $85 and an average cap rate of 7.7%. A significant sales transaction in 2023 included Parkway acquiring a 2.7 million-sq.-ft. portfolio—7 buildings and 9.91 acres of land—of CityWest Place and Post Oak Central. The properties were 76.6% leased at the time of sale. Canada Pension Plan Investments sold the properties and land for $330 million in September 2023.

Record-High Asking Rent
Houston’s overall full-service average rent increased to $30.42 per sq. ft.—a record-high for the metro’s office sector—up slightly from the previous year’s $30.02 per sq. ft. Asking rents for overall Class A and Class B space are at $35.47 per sq. ft. and $23.07 per sq. ft., respectively. The submarkets with the highest year-over-year increases in asking rents include the Northeast at $22.20 per sq. ft. (10.5%), followed by the Northwest at $18.12 per sq. ft. (8.5%). Given the market’s current leasing environment and available space (68.1 million sq. ft.), minimal rent increases will continue throughout 2024.

Alex Babcock
Senior Research Analyst
[email protected]
tel 713 275 9618