In my commercial real estate career of 33-plus years, I have seen a number of opportunistic points in time to purchase office buildings at a favorable basis in Houston. I can confidently say that right now is one such time. With that said, it may just be the best time in decades to acquire an office asset here.
As we all know, Covid has forever changed the way humanity works, lives, eats, socializes, and so on. The jury is still out for some on what the backside of this pandemic will look like and how the office market will adjust to the hybrid or remote work strategies. But one thing is for sure: Houston is in recovery mode.
Companies and individuals are relocating from the West and East coasts to Houston. This boom is a result of Texas and our city of Houston having no state income tax, a diverse employee pool, and a pro-business atmosphere. Relocation of employers and employees over the next several years is poised to fuel the increase of office occupancy to levels we have not seen in the past.
We are observing a common thread among many older office properties we are marketing. They have low occupancies and/or distressed debt and are trading at values that will position the next round of owners to achieve returns in excess of 30 percent IRRs with a much lower risk basis. According to Avison Young’s year-end 2021 Houston office market report, leasing activity was 10 million square feet—a 20-year low. Absorption for the past two years has been a negative 5.7 million square feet with an increasing overall vacancy from 22.1 percent in 2020 to 23.2 percent in the fourth quarter of 2021. Office asset pricing ($189 per square foot currently) is also down 30 percent from March 2020 ($270 per square foot). These metrics are setting the stage for one of the best opportunities to purchase value-add office properties in Houston.
Additionally, recently completed Class A office properties with strong occupancies and long-term tenancy are anticipated to trade at near-record and record pricing this year and well into 2023. As of the end of the fourth quarter of 2021, there were 84 properties proposed, under construction or under renovation totaling approximately 16.3 million square feet. In recently constructed buildings, investors see the potential for long-term tenancy and garner premium rental rates.
The spread of values between value-add and Class A categories will be significant in the Houston office market this year and into 2023. We have had the benefit of being in the midst of significant transactions and hearing investors wants and concerns, in order to better understand what the future holds for this exciting market.
The bottom line is Houston will see a new wave of investors who have a high confidence in the city’s future success, data metrics and the new frontier in this ever-changing world of opportunities. This is possibly the best entrance to the next run of returns for commercial office buildings that the market has ever seen.
Darrell Betts, CCIM, is principal/Capital Markets for Avison Young Houston.