Houston — A Tale of Two Cities: Through the Looking Glass of Residents and Outside Investors

Blake D. Royal, Lyndsay Fincher

February 9, 2018

“If you change the way you look at things, the things you look at change.” –Wayne Dyer

With everything that has occurred in Houston over the past few years, it can be difficult for its residents to understand the opportunities that are seen by those viewing the city from the outside. Houston can be characterized as the tale of two cities: the city seen from the perspective of its residents versus the city seen from the perspective of outside investors. For those of us living in Houston, many experienced first-hand the effects of the energy downturn and Hurricane Harvey, which resulted in vacant office buildings, retail and multi-family in the Energy Corridor and flooded residential homes. As a result, it is understandable that some Houstonians have a pessimistic view of our current situation, a World Series championship notwithstanding.

However, for those outside of the city, Houston is an attractive investment opportunity and investors are speaking with their dollars. For them, Houston is a good value-add proposition for many types of real estate – including industrial and multi-family, while the office and retail segments are adapting to new challenges.

Industrial

The industrial market is currently Houston’s most dynamic market segment, with explosive growth in development over the past five years. Developments that, in the past, might have gone to Dallas, Los Angeles, Chicago or Atlanta have come to Houston. The developments are also getting larger; where the average square footage of projects was approximately 35,000 sq. ft. just a few years ago, the average size has essentially doubled to approximately 70,000 sq. ft. in recent years.

The explosion in the industrial market is driven by a number of factors: the expansion of e-commerce, new housing development and redevelopment in the Greater Houston area, the expansion of the Panama Canal, and new petrochemical plants and refineries coming online. An unlikely foe, Harvey, has resulted in major retailers such as Home Depot and Lowes opening new distribution centers to serve the need for increased housing materials. One of the biggest changes in the industrial market is the expansion of requested amenities, ranging from higher ceilings to wider column spacing. In addition to the new development, Houston can expect to see redevelopment of older buildings to meet tenants’ demands.

With all of the growth in the industrial market, sites are becoming harder to find in rail-served areas such as Baytown, LaPorte and Deer Park. Whereas industrial was once the highest and best use of land in those areas, there is now competition for multi-family and single-family residential developments. In response to the scarcity of land, developers are looking beyond traditional, rail-served industrial areas to Katy and Brookshire, which are further from downtown, the Port of Houston and railyards.

Multi-Family

It may come as a surprise that Houston may actually be on the precipice of an undersupply of multi-family units in light of the numerous new developments that have been delivered in the past few years. As the number of new projects has slowed, the excess units have been absorbed and the market is stabilizing. With fewer new units slated to come into the market over the next few years and the high projected growth of Houston’s population, the existing multi-family units will quickly be absorbed.

Interestingly, while many of the new multi-family projects included higher-end amenities targeted towards millennials, these developments are in fact attracting older generations who enjoy the amenities and, in mixed-use developments, the ability to walk to restaurants, stores, and other destinations right outside of their front door.

Office

The Houston office market continues to face challenges, but while some are unique to Houston, many are the same challenges being addressed in markets worldwide. A challenge that is particular to Houston is the oversupply of sublease space, which is a remnant of the drop in oil prices that left a glut of unused office space. While the sublease market may be healthy, subleases do not impact the overall net absorption of office space.

Now that oil prices are stabilizing – hopefully, for the long run – we are seeing a secondary effect on the office market. This effect is being seen on a national and worldwide level: companies are changing the way they are structured, which is changing the use of their offices. Business owners, especially small business owners, are hesitant to commit to long-term or large-scale leases because their use will fluctuate. In addition, companies are utilizing more contract labor than before, which allows their workforce to constrict and expand to meet their needs. The net result is that leases are for smaller spaces and shorter timelines.

From an investment standpoint of a small business owner, a 10-year lease may seem too risky, but a shorter lease, or even a month-to-month lease, may be an easier commitment. At the extreme end of this shift is the rise of flexible collaborative office space providers, such as WeWork and Spaces. With all of these perceived challenges, however, Houston is seeing an increased investment in its office market from institutional investors, which speaks to the confidence that those outside of Houston have in the region.

Retail

The story in retail continues to be impacted by e-commerce. There continues to be a vast sales gap between e-commerce and brick-and-mortar stores, but it is a shrinking one, and savvy retailers (and retail developers) are making adjustments to account for this growing challenge. Consumers who enjoy the experience of high-end shopping will continue to go to the stores they enjoy, but those retailers are making adjustments to ensure that their customers continue to enjoy shopping in an interactive way.

For day-to-day items like diapers and dog food, however, consumers are increasingly turning to online, automatic delivery options. In response, retailers are integrating automated and online interfaces with their physical locations, such as grocery stores providing internet ordering and curbside pick-up, and soft goods retailers providing for more easily accessible in-store returns for items purchased online. The rise in online purchases will also have other effects, such as smaller footprints for “big box” retailers, and the rise of “lifestyle” centers that provide experiences rather than mere shopping.

From an investment standpoint of a small business owner, a 10-year lease may seem too risky, but a shorter lease, or even a month-to-month lease, may be an easier commitment. At the extreme end of this shift is the rise of flexible collaborative office space providers, such as WeWork and Spaces. With all of these perceived challenges, however, Houston is seeing an increased investment in its office market from institutional investors, which speaks to the confidence that those outside of Houston have in the region.

Conclusion

Houston is overcoming its perception as a city whose economic health is solely tied to the price of oil. Despite all of the recent travails our city has dealt with – and continues to deal with – there are many reasons to be optimistic about the Houston real estate markets and to see ourselves as others see us – a great real estate opportunity.