Sub-market Report - CBD

The skies for Hines got much more blue when BG Group signed up for 164K SF (expanding to 354K SF)

Overview:

Absorption: While 2010 saw negative absorption of (-276K SF) the fourth quarter showed signs of life with only the second positive quarter of absorption in two years.

Availability: There is over 1.5 million SF of space becoming available in the submarket (BG Group Place and Devon Energy's sublease to name just a few).

Rent rates falling: The large amounts of space that will become available in 2011 should continue the downward pressure on rates.

New Development: BG Group Place and Hess Tower will arrive on the market.

Yesterday was the official opening celebration of the Hines BG Group Place. It was quite a party and Hines has had a reason celebrate as BG Group ended the year with the announcement of a relocation and expansion. The 164K SF initial lease will grow to 354K SF as BG will exercise the expansion right of the mid-rise block of the building. This will lessen the impact of the 972,474K SF delivery this month.

There appears to be a positive trend of absorption so far through February of 2011. In 4Q 2010, Black Stone Minerals Company they grew their HQ at First City Tower by 13,119 SF to 55K SF with a six-year renewal and expansion. Sublease space also decreased by 15% as the remainder of the 116K SF RRI sublease was removed from the market.

Continental Tower - Trouble brewing?

While this news gives the impression that CBD fundamental's are strong. there is an undercurrent that most people in the market is aware of. Not counting the BG Group arrival (which will bring 500K SF of vacancy), there is potentially 2.5 MM SF in play that could push vacancy up and rents down. This 2.5 MM SF is made up of the following:

• One Allen Center has Hess vacating for their new digs (338K SF is moving to Hess tower).
• Two Allen Center has Devon Energy's 281K SF sublease space (becoming available in April of 2011)
• Three Allen Center has the remainder of Devon's sublease space with 120K SF becoming available in April of 2011.
• Two Houston Center has the Shell trading space of 248K SF becoming available in Q3 of 2013
• 700 Milam has Shell's 554K SF which expires 12/2013
• And 1600 Smith Street has the 414K SF Continental Airlines expiring on 12/2014 and Chevron's 250K SF expiring on 3/2011

Forecast:

While all of these are potential threats to the CBD's stability we believe the trajectory of absorption and lack of new development (after the two big deliveries) should help the submarket weather the storm. The sale of Heritage Plaza to Brookfield for $321.5 million is further evidence of the growing confidence in the Houston CBD by investor. Hoping not to miss out on the action, MetLife has put a 50% stake of Wells Fargo Plaza on the market. With strong fundamentals, we are cautiously optimistic about the trajectory of the CBD market.

Open Space Planning - The New Normal?

Open floor plans like the one above that value efficiency is a growing trend

The generation Y preference, the great recession, and a general trend towards cost savings are leading to more efficient space planning for office tenants. The average space per employee is down to 200 SF (down from 500 SF -700 SF) and this article from the LA times estimates that allocation could get down to 50 SF per employee by 2015 . There is no doubt that we are seeing a trend towards more collaborative, efficient, and open floor plans with workstations (with fewer private offices) that is leading to less space needed per employee. The real question is whether this is cyclical in nature or if this is a "new normal" for office space users. In Houston, our energy tenants do not seem to be on the same trajectory, still valuing private offices and keeping a higher ratio. One thing is for certain: No matter the ratio of employee per SF we need more employees (ie job growth is imperative for the office recovery.)

CNBC - 2011 CRE Outlook

There were two phrases you had to throw around in 2010 if you wanted to sound cool: Will Commercial Real Estate be the "next shoe to drop" and how we are experiencing a "bifurcated market". Maria at CNBC mentions both in this recent interview with Hessam Nadji of Marcus & Millichap Research and Advisory Services and Neal Elkin of Real Estate Analytics. Here are some highlights:

• The Big Drop: CRE prices went 42% since peak from 07 through 09 creating a great basis for investors heading into '10.
• Class A trophy asset up 40% since summer: There really was only an appetite for proven assets in proven markets. With large pools of institutional money on the sideline, Blue chip assets appreciated substantially in 2010.
• Secondary assets, in tertiary markets discounted: There were actuall discounts to really weak properties, but no real desire for the mid tier assets.
• Projections: There will be a broadening of the buying appetite for the B and B- assets in 2011 as interest rates still low and risk aversion begins to fade

Sub-Market Report: Galleria

With Stanford's space backfilled by Southern Union, Walton Street Capital

(with HFF's help) hopes to trade the towers for a pretty penny.

Overview:

• Absorption: Q3 resulted in negative (35,026) SF absorption. However the sub-market for the year has netted 164,582 SF of positive absorption with positive activity so far in Q4.
• Big Relocation's: Weatherford's move of 335K SF to 2000 St James and Southern Union's move of 193K SF to Galleria Tower II are the largest of a handfull of relocations in the sub-market.
• Rent rates steady: Despite a soft market, quoted rental rates are higher today ($26.43) than before the recession in 2Q 2008 ($26.17). See chart below for more detail.
• New Development: Skanska and/or Hines may be the first developers to go vertical on new construction in the area in 28 years.

Galleria tenants finally took advantage of a market that turned strongly in their favor and subsequently made some long term lease decisions with relocations and renewals. Large moves ranged from Weatherford consolidating under one roof by taking down 335K SF at 2000 St. James Place, to Southern Union leaving 5444 Westheimer to back fill 193K SF of the old Stanford space at Galleria Tower II (increasing occupancy from 32% to 91%), to Quanta Services leasing floors 26-29 (90,704 SF) in Williams Tower. The large renewals of the year included Suez Energy re-upping for 130K SF at Post Oak Central Three, Cameron International renewing 70K SF at Park Towers, Intertek taking 45K SF of sublease space at Two Riverway, and IES renewing their 20K lease at 1800 West Loop.

There appears to be a positive trend of absorption so far through the fourth quarter. With Gordon Arata McCollam Duplantis & Eagan leasing 16K SF on a full floor of Two Post Oak Central and BHP set to absorb the vacated Quanta Services space, there is a good trajectory heading into 2011.

The BHP Billiton Tower is further solidified as BHP will take the Quanta Services space. BHP will occupy 100% of the 1360 Post Oak Blvd

While the recent activity and overall year to date absorption are positives, there are some downside risks that Galleria Landlords should be cognizant of as 2011 approaches. Customer retention practices will be critical as two new developments will be very intent to pull an anchor tenant from a competing Galleria building. Skanska has a 19 story tower teed up on the 2.3 acres lot on Post Oak and Hidalgo and Hines is back in the game thinking about buidling in the BLVD Place mixed use development at Post Oak and San Felipe. Both are very active in their perspective pursuits to court tenants with upcoming rollovers. Landlord management teams would be wise to be intentional with all customers and focus on best management practices that lead to tenant retention. In addition there is the concern that large tenants may follow BG Group's lead and look to move from the Suburbs to the CBD.

However, there is good reason to be optimistic about next year. There are a number of deals that are on the market to include Apache, Litton Loan Servicing, and Met Life -- all with potentially growing requirements. With rent rates holding firm through the softening of the market, we would expect a gradual increase in rates and a decrease in concessions if demand does pick up. The Galleria is one of the most active sub-markets in investment sales activity with a number of trophy assets on the market. The Lakes on Post Oak, Marathon Oil Tower, and are all activity being marketed by talented investment sales teams. With a continued increase in activity, steady rents, and mitigating concession, we feel the Galleria will be one of the leading sub-markets for the recovery.

And now for the obligatory (but hopefully helpful) charts*:

Galleria Vacancy (Q4 '06 to Q3 '10)

Galleria Absorption (Q4'06 to Q3 '10)

Galleria Rent Rates (Q4 '06 to Q3 '10)

* All data provided by CoStar

Houston Jobs Report: Good but slow growth

The Greater Houston Partnership released its December 2010 Economic Report and once again the employment data shows positive job growth (albeit at a slow pace).

The 10-county Houston/Sugar Land/Baytown Metropolitan Statistical Area gained 6,200 jobs, growing .2 % from 10/31/09 to 10/31/10. This is the second consecutive month of year-over-year increases, hopefully pointing to a Houston recovery.

Across the country, Austin continues to hold the number one position on a year-over-year basis growing 2.4% followed by Charleston: 1.91%, Phoenix: 1.42%, and D.C: 1.31%. While no one is complaining about the news, the question remains: Will the trajectory pick up, or will this be a long and drawn out recovery that Houston climbs out of at very small intervals

Houston Overview by Submarket

*All data provided by CoStar

Sub-Market Report: Greenway Plaza

This landmark Tower should be the beneficiary of large blocks coming off the market.

Quick Overview:

+ Leasing Velocity Improves: Positive Net Absorption was up 49K in Q3 2010 with positive activity thus far in the Q4.

+ Invesco stays put: Invesco inked Houston's largest renewal in 2010 (387 K) in 11 Greenway Plaza on 11/22/10.

+ Rent rates inch down: Quoted Rental Rates are down slightly but holding relatively firm as compared to the broader Houston market.

We all know Greenway Plaza has an incredibly strategic location between the CBD and Galleria, with excellent access to the US-59, Westpark Tollway, and Loop 610. But with only 3 of the past 11 quarters (see chart below) providing positive net absorption, it is safe to say this sub-market has been in a little bit of a funk.

The funk may just be over.

With Invesco signing the largest lease renewal in Houston, Phoenix tower inking 23,373 SF (3 leases signed on 11/11/10), and a positive trend of overall absorption in Q4, Greenway Plaza landlords could be gaining a little more leverage heading into 2011.

The Invesco sign will hang there for at least 10 more years

Tenants are starting to get the picture that it will not be their market forever and the early renewals and long term rate structures the market is seeing is a sign tenants are trying to capitalize on current market conditions before the tide turns.

We expect the Greenway Plaza market to continue to strengthen for the foreseeable future. The supply side is in the favor of the Landlords as the sub-market has a high barrier to entry a no plans for new development in the near term. The downside risk is actually created by another sub-market. Greenway Plaza landlords should be on guard as there will be a strong pursuit from two new developments in the Galleria sub-market to pull a large tenant from another building. Skanska has a 19 story tower teed up on the 2.3 acres lot on Post Oak and Hidalgo and Hines is back in the game thinking about going vertical on a site at Post Oak and San Felipe. While Skanska is going spec with their building we know they are busy talking to some major tenants with rollovers in 2011, 2012, 2013, (and beyond). Hines is looking for a BTS and will be actively searching for the right tenant to pull so they can break ground on their site. Landlord management teams would be wise to stay in front of all customers and focus on best management practices that lead to tenant retention.

Forecast:

Even with the risks associated with competing new developments, the Greenway Plaza market should tighten in 2011. The deep amenity base, high barriers for entry, and stellar location make it a great market to own office space. We anticipate slow but consistent absorption with rental rates that have found a bottom in Q4 2010 and should remain steady during 2011. With the amount of large contiguous blocks becoming rare, we expect large tenants to make serious consideration for the landmark Phoenix Tower.

And now for the obligatory (but hopefully helpful) charts*:

* All data provided by CoStar

CoStar Report: CNBC Video

CoStar Report says CRE prices have taken a 3.88% dip across all property types this quarter.

CRE Cliffnotes (11.15.10)

"Flight to Quality" ~ a two way street

• Link
• Two Sentence Overview: More often than not, you will hear the phrase “Flight to Quality” associated with office tenants who upgrade from class B spaces to class A spaces. This is a short blog post that describes what we have seen in regards to tenants looking to upgrade to higher quality landlords as well.
• One Sentence Takeaway: As we continue to climb out of this soft market tenants will look to upgrade space, but will also be looking to upgrade their building's ownership.

CBD’s going strong

• Link
• Two Sentence Overview: CW’s 3Q US office report indicates that 18 of 30 major US CBDs showed increases in leasing activity. This general rise in activity led to declines in vacancy in most markets.
• One Sentence Takeaway: This report is another indication that we may have found a floor but that a recovery back to pre recession fundamentals will probably be a long and slow one.

No New Permits

• Link
• Two Sentence Overview: The Obama administration reluctantly lifted the drilling moratorium over a month ago, but no new drilling permits have been issued in the Gulf of Mexico since the ban ended. The longer permits are stifled the more direct impact this moratorium will have on Houston jobs.
• One Sentence Takeaway: As a result of the midterm elections we may see additional pressure for more permits, but 2011 will more than likely be slow, resulting in a drop in oil output which more than likely will affect jobs in this sector.

Business Week: Oil to $100 a Barrel?

• Link
• Two Sentence Overview: Oil prices have remained relatively benign for most of the year (staying around $78 a barrel) due to slow global growth and large inventories and supply. With the Fed weakening the dollar by printing money (buying $600 of Treasuries) and global demand picking up during the recovery, we could see a run up in oil prices.
• One Sentence Takeaway: Just from my narrow Houston Office space mind, $100 a barrel oil could be a good indicator for positive absorption in 2011.