Houston Has Familiar Real Estate Outlook, Cautious Optimism

Blake D. Royal, Cassie B. Stinson

January 14, 2015

To its residents, the development of Houston has long been a steady train, always churning toward progress despite setbacks and obstacles. Recently, however, the obstacles have been few and the result is a Houston that would be unrecognizable not only to its forefathers, but to any visitor who last set foot here five years ago. The miraculous reemergence of the United States’ domestic energy industry has been a boon to all industries in our nation’s energy capital, but with the recent drop in oil prices, what is in store for Houston and its surrounding communities? Have we learned our lessons from the past or have the last five years been too good to be true? The outlook is one familiar to all Houstonians regardless of vintage: cautious optimism.

Residential Land Development And Home Building

The Houston residential market is making up for lost time. The local economy has made a full recovery from the recession of 2008-2010, and homebuilders are working at full capacity to meet the pent-up demand. Builders cannot build homes fast enough for the thousands of new residents taking advantage of Houston’s unparalleled job growth. Home inventory is low – 2.5 to 3 months – and while the number of spec homes under construction is at its highest level in four years, the inventory of completed spec homes is at its lowest level during the same period.

What is preventing builders from meeting the demand at a higher pace? The first issue is that land development is still catching up. There have been more home starts than finished lots in every quarter since the fourth quarter of 2008. While this deficit is rapidly diminishing, the greatest factor is time: it takes 18 months on average to fully develop a neighborhood of lots. As more lots are completed, the number of new starts will increase dramatically.

The second issue is capacity constraints. The acceleration of demand has outpaced supply, resulting in higher costs for raw materials and fabricated components and a tighter market for skilled contractors and professional service providers. Finally, the resale market has tightened, which has placed greater demand on new product. Current residents are finding it increasingly harder to justify a move within Houston. Many owners find that the value of their homes has increased beyond what they are willing to spend on a new home, and any move would be a lateral one at best. Other owners recognize the location cannot be replaced and opt to remodel their existing home.

At the very least, the current demand for homes should steady despite the recent uncertainty in the energy industry. In fact, it may give builders some breathing room to create the inventory reflective of a healthy residential market.

Retail

The growth in retail developments – particularly grocery-anchored retail developments – follows the growth in residential construction: retail tenants want to be where their customers live. As the economy in Houston has grown, so have new neighborhoods and new retail centers.

In Houston, the growth has largely been in the northern and western regions of the metropolitan area. The majority of new retail developments have followed the growth and anticipated growth of residents and residential developments in these areas. As the new transportation corridors in these areas – namely the northwest portion of the Grand Parkway – are completed, there will be additional projects brought to the market. In addition to the suburban developments, there have also been some recent redeveloped centers in the city proper, as older properties have been reclaimed for new uses. Again, this is driven by the growth in the number of consumers. As the urban population grows, so will retail development.

Houston’s growth has also attracted retail brands that are new to the market. This competition for space, coupled with the slow-but-steady growth in new developments, has created a market in which demand has outpaced supply to the extent that retail rental rates have increased slightly after several years of stagnation. From a resale perspective, the market has stabilized after the uncertainty of the recession, with newer properties with creditworthy tenants fetching several bids and healthy cap rates.

Office Market And Mixed Use Developments

While all market sectors have benefitted from Houston’s economic surge, the office sector has seen the fastest growth. But the rapid ascension is balanced by the potential for a rapid decline: the office market is also the sector that will feel the first effects of a fall in the price of oil. Approximately 40% of recent new developments are located in the Energy Corridor, with many buildings being leased in large blocks by the largest energy production and services companies in the region. So far, developers have managed to maintain a healthy balance in the market, with a majority of space being owner-occupied or preleased prior to construction. It remains to be seen, however, if recently announced projects will be able to continue this trajectory.

Houston has long had a reputation as a city of opportunity, where hard work is appreciated and jobs are available for those who want them. In recent years, however, it has earned a reputation for not only being a great place to work, but also a great place to live. Increased investment in parks and local infrastructure has increased the appeal of urban living, and Houston has proven that it is not immune to recent national development trends, such as increased density – despite its fame for a lack of zoning laws and regulations – and the rise of mixed-use developments. These developments, which integrate at least three separate revenue-generating uses, appeal to a new generation of office workers who seek lifestyle amenities close to the workplace. Houston has already seen the development of several successful projects, and with more in the midst of construction, the city will continue to be a national leader in this product type.

Industrial

The industrial market in Houston has been a constant through turbulent times. Never feeling the full brunt of the recession, it has also recovered at a slower, but always steady, pace.

This is due in large part to the balanced nature of Houston’s energy industry. Exploration and production companies may feel the squeeze of the low price of oil, but the downstream refining and processing companies reap the benefits. Luckily, Houston is home to all facets of the industry, and while one may slow, the others pick up the slack. In addition, Houston has become an increasingly important distribution and logistics hub, with access to all major modes of transportation: road, rail, air and sea.

The result is a largely even market, with decreasing vacancy rates and a balance of absorption of new construction. Demand for industrial products will continue to increase as tenants seek more specialized spaces. Furthermore, Houston is poised to capitalize on its established infrastructure, with the Port of Houston growing in anticipation of the completion of the expansion of the Panama Canal, which will open additional opportunities for trade with Asia.

Other than the price of oil, the only factor on the horizon that can slow the steady growth of the various real estate markets in Houston is land prices. Industrial, residential, retail and office developers are all fighting for the same pieces of the pie in an increasingly crowded market. But all in all, this is a good problem to have: it shows just how appealing Houston has become as a place to live, work and dream.