Office Tenant Demands and Houston's Office Market Update

May 3, 2023

The Houston office real estate market is a dynamic and constantly evolving sector that is vital to the city's economy. As one of the largest cities in the United States, Houston is home to many businesses, from multinational petroleum corporations to small start-ups. A growing population, a thriving business community, and favorable tax policies have driven the demand for office space in the city. As a result, the market has seen significant changes in recent years, including new developments, record rental rates, and shifts in demand from traditional office spaces to more flexible and collaborative workspaces.

To better understand Houston's office market, the team collaborated with Bryant Lach, Senior Vice President at JLL. Lach originally aspired to become a professional golfer, but after a few years on the NGA tour, he decided to transition into commercial real estate. Lach brings ten years of tenant representation experience and unique insights into tenant demand.

Energetic Economy

Houston's economy is primarily driven by the energy markets, often called the Energy Capital of the World. The metro is home to over 4,600 energy-related firms and their subsidiaries. Overall, the economy has remained resilient, adding 18,000 jobs in the first two months of this year. The Greater Houston Partnership forecasted an additional 60,000 jobs added to the metro this year. The growing job market has attracted new residents; last year, the metro's population grew by 125,000.

Office Fundamentals

Houston is a large and very pocketed market; the different submarkets can have wildly different rent trends and vacancies. Overall the market has a 26% direct vacancy rate, and the average rent is around $31 PSF citywide, which has remained relatively consistent.

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Office - Median Securitized Cap Rate Powered by Rockval™ & Trepp®

Demand has shifted to Class A+ or recently renovated Class B to Class A properties. "We're pushing the highest rental rates we've ever seen in Houston for brand-new product. Much of that is due to the construction costs, and tenants are still opting for high-end Class A+ buildings to get their employees excited to return to the office," Lach explains. Even though construction and rental costs are higher, many companies are downsizing by 20-30%, which allows them to afford Class A options. When asked about the return to the office, Lach says it is hard to nail down. On an anecdotal reference, he says the highways are packed during traditional commute times.

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Data set through March 2022 - March 2023 Powered by Rockval™ & Compstak®

According to Lach, The Woodlands is the submarket with the most momentum. The addition of ExxonMobil's Houston Campus and the new headquarters for Hewlett Packard Enterprise put this market on the map. The Woodlands provides newer product and an accessible location for employees; the vacancy rate is 16%, and the median effective rent is $37.21 PSF. "The Woodlands really provides a live-work-play lifestyle that is attractive to both employers and employees", Lach explains. Sugarland closely follows with a median effective rent of $36.97 PSF. Both Sugarland and The Woodlands are suburban markets with easy accessibility to employees.

Tenants Demand Optionality

While the flight to quality is talked about nationally, Lach gave some unique perspectives into what companies are bargaining for today. Tenants realized during the pandemic they cannot be caught holding the bag. Since a majority of companies have downsized and are unsure of future space requirements, the option to expand or reduce space is very common in today's leases.

When it comes to picking a space, natural light has become one of the focal points. New Class A buildings are glass from floor to ceiling, including offices and conference rooms, with the hopes of creating an inviting and productive space. Connectivity is also a requirement these days; employees need to be able to go throughout the property on wifi. Another unique requirement Lach has recently seen is parking security.

"The most important and overlooked factor is the demand for a good landlord. A lot of tenants didn't realize the importance of a good owner until COVID came along. Then some owners were willing to work with their tenants and figure out what makes sense for both the tenant in terms of your company operations and me as a landlord. I think that the good owners have really risen to the top of a shortlist of buildings because you know that you're getting if times get tough, you can work with them."

Key Takeaway

Houston's office market is vast and highly segmented, and like most major markets, Class B and C properties are struggling to backfill space. As a landlord, it is important to provide optionality and amenities to attract tenants. Some owners have decided to get out of office altogether; this has prompted multiple office-to-residential conversations in the metro. As no one can predict what the future holds for the office market as a whole, Houston's expansive economy will continue to demand Class A office space well throughout the year.

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