Houston’s commercial leasing market is a tale of two tenants

January 14, 2008
For Houston’s office market, recent trends are separating tenants into two camps: One is the large, national and international firm where higher occupancy costs constitute only a portion of their corporate overhead; and the second group is comprised of smaller or privately held firms where an increase in rent is forcing changes to where and how they do business.

Borrowing from the Dickens classic novel, it’s "A Tale of Two Cities" -- the average $10 per square foot increase in citywide office rent experienced in less than 18 months has divided Houston’s office tenants into two distinct office users. It’s a tale of two tenants.

Those businesses that want or need to be located downtown are seeing the most change. Whereas the "net" lease used to be an exception, operating expenses are now a separate component in a majority of the Central Business District’s buildings. And when the operating expense component is added to the net rents, along with the cost per space for employee parking, tenants in the best quality Class A buildings are looking at an equivalent "gross" rent in the range of $35 to $45 per square foot. The combination of higher rents and decreased availability is pushing many downtown tenants to consider non-CBD markets.

The high end
Houston’s rapid run-up of office rents is the product of several factors including strong job growth (more than 60,000 jobs added in the last 12 months), little new office construction relative to the current demand and new building owners anxious to increase the return on their investment. It is important to note, however, that Houston’s average Class A office rent of $26 per square foot when compared to the $60 per square foot rents now being paid in other energy-centric cities like Calgary, looks like a relative bargain.

Even at high rents, growing energy and engineering companies with increased project work are actively hiring more employees and continuing to gobble large chunks of space. Recent examples include Foster Wheeler’s lease of 332,000 square feet at Energy Center and the 235,000-square-foot lease for Exterran, the merged company of Universal Compression and Hanover in Greenspoint buildings formerly occupied by Kerr-McGee.

Suburban submarkets
In comparison, for those small and medium-sized companies that constitute a large part of the Houston office market, higher occupancy costs are causing them to rethink their facility decisions. Privately-held law, service and professional firms are reluctant to pass their rent increases on to their own customers, and do not like the concept of rent diminishing their "bottom line."

These companies will gravitate into suburban submarkets that are less pricey, and many have opted for "flex" space where typical occupancy costs of $17 per square foot allow them to maintain their current rent expense.

Green component
Further dividing the tenant market is the increasing preference among companies to select office locations in "green" buildings that are certified as LEED (Leader in Energy and Environmental Design) projects. The LEED rating system was devised by the U.S. Green Building Council to determine whether a project is ecologically friendly.

At the very least, many tenants value the projected operating expense savings by locating their office space in a project that has an Energy Star rating. The management teams of major Houston space users, Shell, Sysco Foods and BP, have all recently made public statements about their commitment for new green facilities. In another show of support, the City of Houston has begun writing eco-friendly certification requirements into its qualifications for city projects. City officials are pushing for LEED certification to be a citywide standard.

While the handful of LEED-certified buildings developed from 2004 to 2006 had been slow to lease up, and tenants had been reluctant to pay the rent premium over other buildings of comparable quality, "going green" now appears to be a prerequisite for a number of companies as they look for space.

In response to this demand, at least five new LEED-qualified office projects have been announced or are under construction, most notably Hines’ 1 million-square-foot downtown Main Place project, and Dienna Nelson Augustine’s 250,000-square-foot project in Westway Park (the second phase to the firm’s successful silver LEED precertified first building).

Workplace utilization
Another trend for those companies reeling from high occupancy costs and lacking expansion opportunities in many of Houston’s Class A buildings is to look at workplace utilization. A choice for some firms is to split their work force, housing executives separately from back-office and support staff.

Still others are choosing to relocate to lower quality, or Class B office buildings to obtain a more economic solution. New workspace options have begun to gain favor as companies examine off-site workspace, telecommuting and the virtual office.

Due to the tightened skilled-labor market, companies are focused on recruitment and retention when calculating the rental rate they can afford to pay. Technological and practical amenities also impact the facility decision as companies measure the impact of cost reduction and employee satisfaction and production.

As small to midsize tenants face the painful economics of their lease renewal or expansion, they will find themselves negotiating in a market that has been moving upward in a strong Houston economy, a sharp contrast to the post-Enron days when Houston was a tenant market.

Julie King and Sue Rogers are senior vice presidents at CresaPartners -- Corporate Real Estate Service Advisors in Houston (