2023 Houston Forecast Summit

Keynote Speaker: Robert W. (Bill) Gilmer, Director, UH Bauer Institute for Regional Planning, Bauer College of Business, University of Houston Takeaway: The U.S. government is currently trying to tame inflation caused by the cash infusion during the pandemic. The challenge is to do this without causing a recession, which requires a delicate fiscal approach.

• We will have no recession, but a very serious slowdown coming soon.

• Trillions of dollars during the pandemic went into the economy via (a) direct stimulation checks to individuals, (b) PPP loans to businesses, and (c) EIDL or Economic Impact Disaster Loans. Some of this cash will be paid back to the government over time, but much will be “forgiven,” adding to the national debt.

• Massive cash injections resulted in increased consumer savings (estimated in the trillions of dollars), stock market purchases driving the market higher and accelerated consumer spending on a large scale. After the pandemic was over, the public continued spending money, fueling ongoing inflation, and a 15% increase in retail sales.

• Inflation eats away at the value of the dollar, which erodes equity buildup in homes and other real estate investments. The goal is to return inflation to the 2% range.

• The recent bank failures can be regarded as “distant thunder” caused by fiscal imbalances in the U.S.

• We are beginning to make some progress in arresting inflation and falling oil prices have helped.

• The Houston economy in general mirrors that of the U.S.

• Houston replaced all jobs lost during COVID by April 2022, but other Texas metros rebounded faster than Houston, largely due to our continuing strong (but declining) dependence on the oil and gas industry. Midland-Odessa’s recovery was slower, like Houston’s.

• Houston is at “practical full employment” with only 4.5% of the workplace out of work or transitioning between jobs.

• New home sales here are down 10% compared to pre-pandemic, resulting in a boost to apartment occupancy. Houston factories, largely dependent on oil and gas work, are in sharp contraction.

• Rather than investing in new research, exploration and production, oil companies are instead cleaning up their balance sheets and distributing profits to investors. The rig count is down 30%. Oil and gas as a percentage of our local economy continues to slowly shrink.

Office Market Update—State of the Market

Moderator: Patrick Duffy, Colliers

Panelists: Abby Alford, CBRE; Amber Carter, Seven Fourteen Realty Inc.; Bob Cromwell, Moody Rambin; Brooks Howell, Gensler; Dougal Cameron, Cameron Management; Steven M. Seltzer, Sheridan Commercial Real Estate Management Group; Trey Miller, Boxer

Takeaway: The office sector in Houston is experiencing a broad shake-up as tenants move downward to lower classes. Some older buildings are almost empty, while some new buildings are full, but select markets like the Katy Freeway, The Woodlands and Uptown have full or near-full buildings. This cycle has been seen before and is expected to work itself out.

• Greater Houston, which is the size of the state of New Jersey, cannot be thought of as “a market,” but as many different submarkets with specific divisions even within the submarkets. It goes building by building, largely according to the age of the building itself. There are myriad pockets of strength and weakness in the office sector, sprinkled all over our regional map.

• Overall, reluctant workers from home are seeing the writing on the wall, and that is that they will be pressured to return to the office. Bosses are working with office building landlords to create a better environment as an incentive/reward for the returning employee. Nationally, the tech sector has reversed direction and is now starting to require “back to the office.” In recent years, Houston’s CBD has added about 5,000 residential units, thanks to subsidies/incentives from City Hall, and our next mayor will have a big impact on this trend.

• When leases expire, some companies are relocating to be near the residences of their employees to reduce commuting time and expense, one of the appealing aspects of working from home. Working from home “spoiled” employees, but studies are slowing reduced productivity from home workers. Savings on childcare expenses are another reason that employees are reluctant to return to distant central workplaces.

• Buildings less than five years old are near full. Pre-1990 buildings have far lower occupancies due to a lack of amenities now expected by returning workers. Overall, Houston has 20–25% vacancy, but as mentioned above, averages are deceiving, and one must evaluate the market more carefully.

• Boxer has successfully experimented with building out entire floors into “spec suites,” which are ready for move-in, as a strategy to avoid extended custom build-out times given permitting delays, unavailability of materials, and other exasperating issues, all of which can be catastrophic to a tenant needing immediate access to a lease space.

• Some office buildings lend themselves to repositioning as residential, but overall, this is a challenging and costly process, and many buildings may be better off being razed. This causes a conundrum for owners (and lenders) of low-occupancy older buildings that are still encumbered by debt.

• Even landmark architectural buildings like Pennzoil Place in the CBD are running at occupancy rates below 50%. What to do with them?

• Owners of “challenged” older buildings are working to add “tenant amenities,” such as food, conference space, fitness centers, outdoor gathering areas, 24-hour accessibility, enhanced security and eco-friendly features, but often there is neither room in and around the building nor money to bring them up to a level that is competitive with new buildings.

• New office buildings that are a part of mixed-use developments are in high demand.

• Investment sales are largely in a holding pattern as lenders and investors are waiting to see how the office sector shakes out. Why buy when interest rates are high, and why sell when prices are low? Lenders who are afraid of having to take back and office building are reluctant to entertain loan applications. What is the exit strategy for the lender on a foreclosed office building?

• B and C suburban buildings are attractive to many small business tenants that need low rent payments. Some larger buildings are bringing in food service via food trucks, and in some cases, cafeteria or catered service on a large scale.

• Statewide, Texas landlords are making the transition to “green.”

Industrial Real Estate Update—State of the Market

Moderator: Christopher Daugherty, Altus Group

Panelists: Boone Smith, Stream Realty Partners; Christen Vestal, Provident Realty Advisors; Peyton Easley, Titan Commercial; Trent Perez, PRD Land Development Services, LLC; Wes Williams, Colliers

Takeaway: Full steam ahead!

• Thirty million square feet are in the pipeline, but land is getting so pricey that deals are not penciling out. Another 30 million square feet were absorbed in 2022, and high land costs are pushing developers further out.

• Rates are up 20%, and another big jump is expected.

• A high percentage of deals are pre-leased, with pre-leasing momentum increasing as the building nears completion.

• There is currently a large demand across the metro area, with port-specific warehouses leading the race. The southeast sector is the hottest, but the north and south beltway are strong, too. Baytown is overflowing toward the east, and 288 S/Pearland, Brookshire, Sealy and Fulshear are heating up.

• Since “time is king,” already built spec facilities are in the highest demand. Fifty-two percent of growth is coming from the expansion of existing tenants.

• Rental rates have doubled in the past three years. Tenants wanting to renew are having sticker shock with up to 30% increases on renewal, but without rent growth, there will be no new construction.

• Some lease terms are shrinking from five to three years.

• Construction costs are beginning to ease as contractors get a little hungry.

• Developers are having more to worry about. Property taxes are going up with higher appraised values; insurance is soaring; cities are increasing requirements for developers; flood maps are changing; loan escrow requirements are increasing, restricting cash flow; and retention requirements are increasing.

• It is getting harder to attract lenders, and investment sales are slowing as buyers wait to see if interest rates will abate. Both buyers and sellers are playing the waiting game. Some industrial owners are finding that their existing user-tenants are better buyers than investors are.

• “Real estate is the best hedge against inflation.”

• Much larger warehouses are in demand now than before, up from 175,000 square feet to 500,000 square feet.

• Houston has graduated from a local to a regional distribution center.

• Industrial construction costs have soared $130,000 to $145,000 per square foot without office buildout.

Retail Update: Opportunities & Trends—State of the Market

Moderator: Eric Lestin, Cushman & Wakefield

Panelists: Christie Amezquita, SHOP Companies; Emily Durham, JLL; Lacee Jacobs, Midway; Thomas Nguyen, CBRE

Takeaway: The demand for space is high, especially for food, beverage and entertainment tenants. Long buildout periods are causing problems for landlords and tenants.

• First-time operators are viewed skeptically by choosy landlords. First-time operators often must start in the far suburbs where rents are cheaper to test out their concepts. Tenants talk to each other about offerings from various landlords, so landlords are advised to hire competent advisors.

• Long buildouts deny revenues to both tenant and landlord.

• EADO offers old building conversion-to-retail opportunities, but it can be difficult and costly, although sometimes it can be more affordable.

• Houston has many exciting missed-use concepts, anchored by creative food and beverage tenants.

• More and more medical tenants are leasing in shopping centers, but lifestyle and entertainment continue to dominate. We are seeing some pediatric and veterinary practices in retail centers.

• Landlords need to better understand the economics of their tenants’ businesses.

• Tenants are offering more “experiential” concepts in their spaces, such as batting cages in Dick’s Sporting Goods.

• Restaurants survived during COVID with food and drink to go, and customers are still in the habit of that. The food and beverage operators who did not adapt to “to go” are hurting. “COVID curbside” never subsided.

• Second-generation food and beverage spaces are in such high demand that many do not hit the market. Houston has one of the top food and beverage markets in the country, largely due to our diversity. We are exporting some of our concepts now to other cities and markets.

• Trends continue toward food and beverage in mixed-use, walkable developments. At the same time, demand continues for end cap drive-thru spaces, which became popular during the pandemic. Demand continues for to-go food and short-term parking for food pick-up.

• Fifty percent pre-lease requirements are now the norm for lenders. Retail new development is waiting a bit now for 2024–25 to see how the economy does. Expect a gentler growth pace.

• Retail development continues to expand to places like Magnolia and Fulshear.

• Some food service concepts are not adaptable to drive-thru window service, which requires a very short prep time.

• Restaurants are looking at empty spaces with drive-thru windows, like closed banks.

Apartment Market Overview—State of the Market

Moderator: Bruce McClenny, ApartmentData.com

Panelists: Clint Duncan, CBRE; JC Clemens, Jr., Flagship Capital Partners; Martin Bronstein, BHW Capital

Takeaway: The building material supply chain remains challenging, and the multifamily market is seeing movement up and down the quality ladder. Occupancy in this market is being driven by people who are priced out of homeownership.

• Rent increases are settling down; landlords are hesitant to lose a good tenant on renewal by upping rates too much. Rents are down 3.5% in Austin.

• Fifteen thousand units were delivered in 2022, and 24,000 units are currently under construction; 18,000 units will be delivered in 2023.

• Costs have grown from $100,000 to as much as $180,000 per unit. Some of this is due to the addition of many amenities, including meeting rooms, offices, walking paths, yoga rooms and many other “lifestyle” items.

• Many developers are waiting for interest rates to stabilize. Lower LTV loans are becoming the norm, with some as low as 55%.

• Investment sales are pausing a bit in this interest rate environment as buyers fear overbuilding coupled with moderating demand. If you have low assumable debt, your project is ripe for a good sale.

• A careful developer does an in-depth study of existing competitors within a mile or so of their proposed project to decide what amenities to include in their project.

• Class B, C and D projects are benefiting from the inability of tenants to afford single-family homes. During tough times, people don’t move into Class A.

• It is harder to obtain fully entitled sites for development as cities toughen their requirements, for example, pertaining to drainage and retention. Developers need far longer due diligence periods to qualify a site.

• Higher tax appraisals lead to higher taxes and higher insurance bills.

• There is liquidity, and deals are getting done, but at higher rates.

• Sharply rising loan escrow requirements for taxes and insurance put a crimp on developer cash flow.

• Management costs are increasing while management companies are stressed to find qualified professional employees.

• Rents are up, but so are operating costs. Rent increases are stressing tenants.

• Eviction proceedings are easing up for landlords as we move away from COVID, but they remain a pesky problem for all involved.