Prospects dire for commercial real estate
Pandemic, oil bust send property market into tailspin that could last for years
A sales brochure for downtown’s 609 Main touts the property’s posh amenities: a stylish cafe where baristas pour third-wave coffee, a state-of-the-art fitness center and a conference and event space large enough for 300 guests.
The 1.1 million-square-foot tower, which opened in 2017 and hit the market last year, drew interest from multiple buyers and was poised to set a price record for the sale of a Houston office building.
But then came COVID-19 and an unprecedented oil bust, a onetwo punch that threw Houston’s commercial property market into a tailspin.
Since mid-March, developers have shelved building plans and office tenants are wary about signing new leases. Shopping center owners with tenants who can’t pay the rent are struggling to stay afloat. Prospective buyers of trophy office towers like 609 Main are taking a pause.
Commercial real estate in Houston is facing a reckoning some say could mirror the dark days of the 1980s when the U.S. economy entered a recession and oil prices plummeted. Toward the end of that decade, Texas became the epicenter of a national real estate collapse. In Houston, property values tumbled and the office vacancy rate soared to 30 percent.
Amid vast uncertainty, analysts have suggested myriad scenarios for the city’s commercial property market. Some say retail centers will suffer the most pain as the pandemic accelerates consumers’ penchant for online shopping. Others wonder if companies will
leave the urban core, drawn to office buildings in the suburbs where it’s less dense.
“You may keep the same amount of office space but maybe you won’t want it in the city anymore,” Victor Calanog, head of CRE Economics at Moody’s Analytics REIS, said in a recent presentation to clients. “Maybe there will be a resurgence in demand for suburban office.”
Office vacancies nationwide are expected to spike to 19.4 percent by the end of 2020, a historic high, according to Moody’s Analytics REIS. The last time they neared that level was during the savings and loan crisis in 1991. Rents are expected to fall by nearly 11 percent this year.
These shifts come as the leasing market is undergoing a period of severe disruption. Companies haven’t been able to tour space and some that were in the process of negotiating new leases are postponing their decisions until they have a better sense of how their businesses will be affected by the coronavirus. “A lot of deals went on pause. Some have died,” said Tim Relyea, executive vice chairman of Cushman & Wakefield of Texas. “Whether they’ll come back, I don’t know.”
Rents nationwide are expected to fall among all major sectors of commercial real estate. CBRE Econometric Advisors forecasts an average of a 10 percent decline in multifamily rents and 3.5 percent in industrial by the end of the year. Strip centers could see declines of 8.5 percent.
The hit to the market comes as Houston’s office market was still trying to recover from the 2014 oil bust. In the wake of that collapse, energy companies retrenched and put millions of square feet of space on the sublease market. At the same time, new towers that had broken ground when a barrel of oil was $100 were coming online.
Investment impact
Now, more real estate fallout is expected as oil and gas companies and the businesses that support them again struggle to stay profitable with oil trading at a quarter of the level of less than a decade ago.
A Cushman & Wakefield report on the impact of COVID-19 and oil price declines in markets sensitive to energy prices said leasing activity in Houston would remain sluggish “indefinitely.”
The area’s 4,600 energyrelated companies account for nearly a third of the nation’s employment in oil and gas extraction, the report said. Despite the efforts at diversification efforts, energy and the price of oil still drive the regional economy.
Job losses in the sector are mounting. University of Houston economist Bill Gilmer recently revised his outlook for Houston. The area, he said, could lose 83,000 net jobs in 2020. His earlier forecast was for an uptick of 49,000 jobs.
As a result of these declines, the region’s commercial real estate market is expected to become less attractive to investors.
KB Securities, a South Korean investment bank that was negotiating to buy 609 Main for $675 million, opted last month not to move forward on the acquisition, according to industry publication Real Estate Alert. The deal fell apart due to financing challenges, the report said, citing market sources. The seller, Houston-based Hines, declined to comment and KB Securities could not be reached.
Still, the downturn will invariably lead to buying opportunities.
Tim Dosch, principal of Dosch Marshall Real Estate, has heard clients say the best deals in Houston will happen over the next couple of years because there will be less competition as low oil prices cause investors to look elsewhere.
Pre-pandemic, a well-located development site might have attracted 20 buyers. “Now it might be a situation where you actually can go buy the property with no competition. Maybe you get a slight discount, 10 to 15 percent, and construction costs could go down,” Dosch said. “That’s pretty significant savings.”
The long haul
Houston-based Camden Property Trust, a national multifamily company with $500 million in cash on its balance sheet and another $900 million available through a line of credit, intentionally positioned itself for a time when the market turned down. That meant raising equity and keeping its borrowing low.
When people would ask Camden CEO Ric Campo about his financial strategy, he would remind them the U.S. was in the longest period of economic recovery in history.
“Something is going to come along that’s going to change that. I don’t know what it is, but when that happens, I want to be positioned to have the best balance sheet in the sector because there should be opportunities that come up over that,” Campo said on an earnings call this month with investors.
Depending on the sector segment, a recovery could be several years away.
The office sector could take two years to return to pre-crisis levels of rents and leasing activity, and industrial and multifamily properties aren’t likely to see some recovery for 12 and 18 months, respectively, according to CBRE.
It could take up to three years for retail and restaurant properties to return to pre-crisis levels of rents and leasing activity.
David Wolff, president of Houston-based land development firm Wolff Cos., said the real estate industry has learned important lessons from previous downturns.
“In the ’80s, banks were pushing money out the door,” he said. Now, lenders are generally more conservative, requiring investors and developers to put more of their own money into a deal.
Wolff is in his sixth decade in commercial real estate. Each one, he said, has had its unique crisis. He recalls double-digit interest rates of the 1970, the oil bust of the 1980s when the mantra was “stay alive till ’85,” and the collapse of Enron and the merchant energy business of the 1990s.
“Now here we are dealing with something we’ve never dealt with before,” he said.
But he takes some comfort in being a privately held company without any debt.
“At a time like this,” Wolff said, “it feels real good.”