Tenants may benefit by staying put for a while

October 31, 2008
Julie King and Sue Rogers, principals with CresaPartners-Houston, say that tenants who defer a move now may discover landlords will be far more willing to renegotiate rates or grant more concessions in a year.

"Houston office tenants renewing or expanding their leases within the last two years have experienced “sticker shock," facing record high rental rates," they note in a market analysis. “Strong job growth in energy and related engineering businesses has been the primary catalyst."

During the third quarter of 2008, however, the national malaise caught up with Houston, they say. They note that Main Place, Hines' new 937,000 square-foot downtown project scheduled for completion in 2010, has announced a 108,000-square-foot lease with KPMG and DNA Westway has secured significant preleasing. But the majority of Houston's 4.4 million square feet of new projects currently under construction with 2009 deliveries have no material preleasing.

“In normal times, assuming no slowdown in job growth, and typical yearly Houston office space absorption 2 million square feet, vacant space in new 2009 office buildings would likely be leased within two years of completion," they say. “But Houston's economic prognosis for the next 24 months is a bit cloudy."

Houston's sublease inventory has increased by almost 1 million square feet in the most recent quarter, with many of the subleases coming from recently moved-in tenants, hoping to downsize in a slowing economy, they say.

King and Rogers also warn tenants that they need to be prepared for large increases in operating expense pass-throughs.

“The big three components of operating expenses - real estate taxes, insurance and maintenance and especially energy costs, have jumped in the last 12 months," they note.

Commercial property values in Harris County increased 34 percent in 2008, with downtown office buildings seeing a 50 percent increase in their tax-assessed values. Energy costs are also up materially.

“As tenants get their expense reconciliations at the end of this year, they should be prepared for average increases of at least $2 a square foot," King & Rogers say.

Cautioning tenants to avoid moving into buildings of lesser quality, in an effort to maintain their current rental expense, they point out that the majority of Houston's Class B and C building inventory was completed in the late 1970s and early 80s.

“The mechanical and air-conditioning systems of these now 20 year old buildings are nearing the end of their useful lives, requiring replacement at considerable cost," they say. “Many of these older generation buildings are also non-compliant with current city energy codes, requiring costly modifications, an expense that landlords are increasingly looking to tenants to bear."

Additionally, tenants are finding that allowances offered by landlords for alterations or new improvements are falling short of the cost of construction.

“Higher gas prices are showing up in higher material costs, with some categories like metal studs and ductwork up almost 30 percent from two years ago," they say.

“Even if the energy sector continues to prosper, a cooling national economy will impact the Houston metropolitan area, they say. “One alternative for tenants facing an expiring lease in the midst of an uncertain environment may be to sign a short-term lease extension and wait for the office market to correct a bit."