REDnews Houston Industrial Summit

BY RAY HANKAMER

Takeaway: Absorption continues to be strong, keeping supply in balance. New development is leveling off as are previously spiraling construction costs. Land is expensive and scarce. Capital markets are tighter for large projects, as lenders await investment transactions which result in their loans being paid off. The future looks strong and balanced, with demand continuing and rents slowly rising to reflect developer costs.

Panel: Industrial Real Estate Market Overview

Moderator: Mike Spears-Lee & Associates Speakers: Brandi Sykes-JBeard Greater Houston; Christen VestalProvident Realty Advisors; Mark Nicholas-JLL; Ryan Byrd-Colliers; Thomas Erwin-Moody Rambin; Travis Land- Partners due to our attractive business climate

• Affecting NOI, insurance premiums are rising along with rising valuations of industrial buildings

• The Port/SE market continues to shine, with 20-30% growth

• Materials availability and permitting delays continue to hinder developers

• Venture capital investors are eyeing non-conventional start-ups in Houston such as life sciences

• Major drivers of demand in Houston are population growth, consumer demand, and increasing activity at our port, as the West Coast ports continue to experience bottlenecks

Bullets:

• The variety in industrial product is wide-ranging: flex space office, storage, manufacturing

• Houston has had a robust growth over past five years, adding over 20% to our warehouse base, and we already were a strong market

• Record construction, absorption, and growth have been our good fortune

• In the middle of this growth, land prices, interest rates, and inflation have soared

• Due to our business-friendly climate here, Houston will prosper while other markets suffer

• One of the ‘headwinds’ is educating equity investors that Houston is different

• There has been a 64% increase in large leases-over 100,000 SF-in recent years

• We currently have about 34 million SF under construction, and if this velocity continues, at the end of 2023 we may have up to 10% vacancy, but most do not expect that

• Will interest rates cause construction to slow?

• Rental rates are increasing sharply

• Average tenant size has increased, with tenants needing 30-50% more space

• All the ingredients in development are up: materials, land, interest rates, labor costs

• Lots of equity remains on the sidelines and available

• End user demand for industrial remains strong

• East and west coast industrial users are coming to Houston-diversifying to us-

• One of the most active sectors now in industrial demand is energy (not specifically oil & gas) but green energy-Houston’s City Fathers wisely wish us to continue to be the Energy Capital of the World, whatever the energy source

• The Port is entering its eleventh expansion phase, with dredging of the Ship Channel to accommodate even larger vessels-our container ship volume is up 26%

Panel: Game Changing Economic Tools Moderator: Danny Nguyen-DN Commercial Speakers: Kristie Young-Beaumont Chamber of Commerce; Stephanie Wiggins-Partnership Lake Houston; Patrick Ezzell-UP Community Development; Brian Malone-Pearland Economic Development Corporation (EDC); Chuck Martinez-Katy Area Economic Development Council

Bullets:

• Industrial tenants are expanding

• The job of economic development councils is to support economic growth by attracting new users and facilitating their opening businesses, to create jobs and tax revenue for the community

• Katy has 10 square miles of territory and 27 million SF of industrial space inventory

• Beaumont needs warehouse space and is seeking developers

• Out of town and out of country users are coming to greater Houston looking for industrial space

• There is an abundance of ‘special districts’ designed to facilitate development and anyone in industrial real estate needs to educate him/herself to the help and the programs that are available; these special districts were created years ago by the State legislature to facilitate residential and commercial development; often these districts can sell bonds and finance infrastructure for developers at no cost to them; special districts can offer great flexibility to developers; maps are available for the location of these special districts and the local EDCs can help-that is their role

• Local banks often compete for a chance to lend to developers in their trade areas

• Some ECD groups offer drone ‘visits’ to their areas so that potential businesses to not have to buy a plane ticket to check out the area; drone ‘scouting’ can be better than driving a market

• There is a wave of new industry looking to replace oil and gas in the Houston area, and these industries are looking for specialized space for biotech and biotech manufacturing, aerospace, and other industries connected to the fight to stop climate change

• Public-private partnerships to help new start-ups abound and the shrewd developer seeks them out; often financing and other breaks are available through these entities; this financing vehicle is just catching on in the Houston area but is used widely elsewhere in the US

• Start-ups need small spaces to begin, with minimum build out; they will customize open spaces to fit their needs

• Texas is very interesting now for investors in the industrial sector; bonds for infrastructure such as utilities and drainage here are easy to sell

• The primary role of EDCs is to provide “solutions” for the developer and for the business wanting to come in to a given area; most EDCs are non-profit

• Beaumont’s Chamber of Commerce is offering job fairs to match high school grads with good jobs

• If real estate is your business, then you should be involved in local politics, so as not to miss the various benefits offered by the various pro-business non-profit districts and other vehicles designed to facilitate economic growth; “Politics is there to help you”

Panel: The State of Economic Development & Investment Moderator: Mike Diehl-Rycon Construction Speakers: David Claros-Dosch Marshall Real Estate; Robert Wheless-Logistics Property Company; Ryan Cordill-Newmark Title Services; Torrey Hawkins- Angler Construction; Craig McKenna-Stream Realty Partners

Bullets:

• Vacancy down and some and 21 million SF have been absorbed out of total of 415 million in Greater Houston; 22.5 million SF are under construction; overall vacancy is 6.5%

• It is a good time to develop in the industrial sector IF you can find affordable land

• 1/3 of development in our area is in the SE, focused on the port

• Construction cost increases are starting to flatten, to level off, although there are still some items which are still rising is cost and/or unavailable within a reasonable time frame

• Permitting is a nightmare in the City of Houston which is working with a 50% manpower shortage; permitting takes so long that developers have trouble guaranteeing pricing long into the unpredictable future

• Developing industrial involves so many variables and surprises along the way, although contingency allowances on budgets are starting to trend downward a little now

• Site and shell costs have ballooned up to 30% in just one year

• Land costs are being bid up all over the area and it is hard to find a site that pencils out for a given project

• Due diligence, which once required only 30-60-90 days now takes 90-100 days

• Leasing rates are difficult to calculate in the future because there may be so many unknowns crop up during the development process; luckily demand drivers continue to be positive

• There is a scarcity of some tenant improvement components (TI); landlords are adding more life safety and other permittable components to the building shell to avoid long waits for approval of them in built out lease spaces, given the delays in getting inspections; with these elements in the shell, the tenant can move right into the finished space sooner; overall more investment is going into the shell that before did not go in until spaces were built out

• Developers continue to order early and warehouse building components which are in short supply, thus compounding the problem

• Some contractors are finding scarce materials offshore and importing them, in spite of additional ‘paperwork’

• Developers continually must be aware of changing tenants’ needs and adapt to meet them

• The cost of providing site ‘entitlements’ such as utility availability, detention, drainage, curb cuts, impact fees, etc., has gone up into the double digits from the single digit cost where it traditionally has been

• Debt / capital markets are in a strange period, with banks waiting for investment sales to take place so they can roll over their money and make it available for new deals; with unfavorable cap rates for sellers’ deal making has slowed down; local banks are available for smaller deals; it may be another year or so until capital markets shake out

• Today’s tenant/users want the latest and greatest state of the art amenities in their buildings, putting older industrial product in a secondary place

• Houston industrial rents remain more moderate than in other US markets

• There is more demand for buildings which can accommodate robotics and AI, and even the smaller established tenants are starting to demand hi-tech buildout

• Huge spec deals are slowing down

• In the immediate future there will be a slight slowdown due to restricted capital availability, although demand remains strong as online sales require warehousing to support it; recent Black Friday set record online sales

• Cautiously optimistic for future and for rents to continue to rise

• Developers should secure sites and begin entitlement on them, preparing for a resumption of industrial growth

• More and more users are wanting to own their buildings

• Buildings are becoming taller with more automation

• Since the market is tightening, landlords hold the upper hand in negotiations

• It is a good time to buy industrial buildings

• The industrial sector is taking baby steps toward more environmentally friendly buildings but the big advances will come from trucking switching over to electric