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