In a surprising turnaround, Houston office landlords are finding that being second choice may not be as detrimental as previously thought.
Following years of tenants gravitating towards newer, high-quality buildings, the recent scarcity of new construction has led to a shift in demand, catching up with supply.
Even though Houston is home to one of the highest office vacancy rates in the nation, top-tier buildings are witnessing high occupancy, which in turn is driving up rental prices and decreasing the array of concessions available to tenants.
This scenario has compelled some tenants to explore older yet well-located options, such as Class-A and select Class-B office buildings.
According to Houston office brokers, this shift points to a broader recovery within the market, providing fain rents and occupancy rates that benefit landlords who were previously facing challenges.
Margaret Hartman, chief operating officer of Hartman Properties, remarked on this evolving trend, noting that the company acquired seven Class-B properties in the Energy Corridor around eight years ago, just as tenant preferences began to change.
By investing in renovations and offering flexible leasing options, Hartman Properties has managed to increase the occupancy rates of these buildings by approximately 27%.
The latest analysis reveals why lesser-known but strategically located offices are again becoming appealing to tenants.
In the first quarter of the year, Houston reported an overall office vacancy rate of 26.3%. However, Class-A properties constructed after 2015 held a significantly lower vacancy rate of 11.7%, according to JLL data.
While the average asking rent in Houston stands at $31.25 per square foot, Class-A buildings command a hefty $36.14, causing some prospective tenants to look elsewhere.
Anya Marmuscak, executive vice president and tenant representative broker for JLL, emphasized that the pressure on rental rates has become evident recently, particularly in top-tier properties.
Her analysis indicates a notable 18.4% vacancy rate difference among Class-A offices based on their construction dates, underscoring the preference for newer buildings.
Significantly, the trend has not only affected the luxury market; Houston’s Class-B office inventory bore 87% of the market’s occupancy losses over the last decade.
Ariel Guerrero, leader of the Texas and Denver region’s insight team for Avison Young, has observed a positive change with a 7% rise in leasing activity for Class-B properties over the past year, ranking as the fourth-highest increase nationally.
Guerrero expressed optimism for the Houston market, stating, “It’s definitely promising to see this because it’s been a very challenging period for Houston over the past 10 years.”
As the previously astronomical concession packages that attracted tenants during the downturn start to fade, many landlords are adjusting their strategies.
Katy Gragg, senior vice president and office agency leasing broker for Transwestern, reflected on the desperate measures landlords resorted to during the downturn, which began with the oil crash in 2014 and was exacerbated by the pandemic.
Two years of offering unprecedented free rent and substantial tenant improvement packages have become less feasible.
Gragg noted that many of the concessions offered previously were unsustainable and merely marketed the potential of the buildings while not making economic sense.
With changing market dynamics, landlords are now seeing a reduction in excessive concession packages.
This shift necessitates ongoing communication and education between brokers and tenants, as a surprising amount of the vacant office space is not within the most desirable buildings.
Gragg noted an instance where a tenant commented on the scarcity of good options available, highlighting the changing landscape.
Landlords like Hartman Properties are adapting to this new reality, aiming to attract tenants who seek quality locations without the premium prices of top-tier buildings.
Hartman commented, “We’re reaping the benefits of our location,” as their buildings approach stabilization and allow for gradual rent increases.
Hartman indicated that they can now push rents up by $1 to $2 per square foot and encounter no challenges finding tenants at these rates.
In contrast, Class-B offices usually appeal to smaller businesses with more modest leasing needs.
While Class-A leases can average between 9,000 and 11,000 square feet, Class-B leases generally fall around 2,300 square feet, providing a beneficial niche for companies.
Adapting to the trends, Hartman Properties has focused on subdividing spaces to create ready-to-lease areas ranging from 1,500 to 3,000 square feet, leading to quick leasing turnarounds.
Guerrero highlighted that Houston has seen considerable leasing activity in Class-B properties, with companies like Frazer, Ezee Fiber, and Blue Cross Blue Shield securing significant square footage.
However, challenges remain; Class-B leasing demand is still 24% lower than pre-pandemic levels.
Currently, Class-B offices have an average vacancy rate of 27.7%, which is slightly above Houston’s overall average.
Yet, as the tighter conditions in top-tier buildings push more tenants to consider alternatives, it is expected that the Class-B sector will gradually recover.
Guerrero anticipates that Houston, having experienced its downturn earlier than many other markets, may emerge as one of the leaders in occupancy growth, albeit at a slower pace than the past boom times.
He concluded on an optimistic note, affirming that the market is showing signs of resilience and readiness for recovery.
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