HOUSTON OFFICE | Q1 2020

Quarterly Market ReportAPRIL 2020

Market Indicators

Current Q1 2020

Prior Quarter Q4 2020

Year Ago Q1 2019

Vacant Direct 20.1% 19.8% 19.2%

Vacant Total 21.5% 21.3% 20.8%

Available Direct 23.6% 23.1% 22.6%

Available Total 26.0% 26.0% 25.3%

Net Absorption (SF) -207,280 776,504 227,065

Leasing Activity (SF) 4,412,913 4,193,950 4,690,360

Construction (SF) 3,403,231 3,655,231 3,128,596

Deliveries (SF) 300,000 109,663 65,943

Avg Asking Rent (Gross) $29.33 $29.84 $29.59

Inventory (SF) 238,567,164 238,267,164 236,846,227

0.0%

3.5%

7.0%

10.5%

14.0%

17.5%

21.0%

24.5%

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ons

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Net Absorption Completions Vacancy

Supply & Demand

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EXECUTIVE SUMMARY

Vacancy rate at 21.5%

The overall vacancy rate in the Houston office market was up 20 basis points quarter-over-quarter, and up 70 basis points year-over-year. The vacancy rate for Class A properties is at 22.2%, and Class B at 22.3%. In the first quarter, overall net absorption totaled negative 207,280 sq. ft.—Class A represented positive 207,297 sq. ft. and Class B corresponded to negative 363,773 sq. ft. Of the 3.4 million sq. ft. currently under construction, about 42% of that space has been spoken for. Of the three properties completed in 2020, totaling 300,000 sq. ft., 97% of that space is leased. The overall Houston average asking full-service rent is at $29.33 per sq. ft.—down from year-end 2019’s $29.84 per sq. ft.—while the Central Business District is averaging $39.34 per sq. ft.

Houston economic indicators

Houston started 2020 with healthy job gains—led by leisure and hospitality, and health industries. Service-providing industries were accelerating, while goods-producing sectors had slight contractions, with modest to no growth in manufacturing. However, oil and stock markets have been whirling from the impacts of COVID-19 on world economies and a flood of crude from OPEC. As noted in NAI Partners’ Houston Office Market QuickTake, these factors have cast a weighty shadow over the outlook for the region. On a year-over-year basis, Houston grew 2.3% (71,100 jobs). Houston’s unemployment rate was flat at 3.8% in February. For comparison, the February unemployment rate was 3.5% in Texas and 3.5% in the U.S. This data precedes the coronavirus (COVID-19) outbreak in the U.S.

As I sit here writing this from my home office, I am thinking of the best way to describe what we are seeing in the Houston office market. Statistically speaking, the numbers

included in this report show a market that that has still not recovered from the Oil Crash of 2014, underscored by negative absorption, an increasing vacancy rate, and flat-to-decreasing rental rates. What the figures don’t show is the major crisis that has evolved over the last 30 days, and I am not just referring to COVID-19. The price war going on between Saudi Arabia and Russia is going to have far greater long-term implications on the Houston office market than the economic shutdown associated with the pandemic.

However, the combination of the demand drop associated with COVID-19 plus the supply-side issues is the proverbial “double whammy.” Job losses in the Houston area are being compared to the dirty words “the 80s”—those that have been in the commercial real estate business for 20-plus years will never forget the low-water mark for the Houston office market was that pivotal decade when oil prices collapsed and the savings and loan crises hit.

Speaking of supply and demand, I think it is important to recognize why this downturn should be different than what was experienced in the 1980s. A significant factor in the crash of the office market back then was supply-side driven. Favorable tax laws created an environment where everyone became a developer. What resulted was a supply increase in the office market the likes of which Houston has never seen. For perspective, to the right is a chart showing the amount of new office space delivered in the Houston market over the last four decades. As you can see, the Houston market added more office space between 1980 and 1989, than during the three following decades combined.

This is significant, and a major reason why we don’t see an office market comparable to the 1980s despite the demand-side issues we are facing and will continue to face in the foreseeable future. Additionally, while still heavily dependent on the energy sector, Houston has diversified its economy and as a result its base of office tenants.

With that said, the Houston office market still has some tough sledding ahead, but the conditions should not mirror what we experienced in the 1980s. I believe we will see conditions further deteriorate (higher vacancy, negative absorption, more landlord-provided concessions and lower rental rates) for the next 18 to 24 months, or until the oil glut is behind us. Don’t expect to see any new cranes for office building construction on the horizon, as any speculative construction has no chance of being financed in this market.

The COVID-19 experience has given rise to other possible trends in the office market. Working from home, social distancing, and space design (less people in more space) will all be subjects of conversations between office brokers, developers and design professionals in the near term. Who knows, the new dirty word for office space in Houston may end up being “collaborative.” Whatever the trends/changes/innovations may be, NAI Partners is here to advise and guide our clients during the best and worst times.

Stay safe and well.

Broker’s PerspectiveQuarterly Market Report

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HOUSTON OFFICE | Q1 2020

“The Houston

market still has

some tough

sledding ahead,

but the conditions

should not mirror

the 1980s.”

Dan BoylesPartner

NAI Partners

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20

40

60

80

100

120

1980-1989 1990-1999 2000-2010 2010-2020

Houston Office Market Construction by Decade

Sq. F

t. (m

illion

s)

MARKET OVERVIEW

Negative net absorption in Q1 2020

During the first quarter, Houston’s office market saw an increase in the number of tenants moving out of space compared to the previous quarter in 2019. The aggregate effect of the net occupancy decline was just over 207,000 sq. ft. of negative absorption for the quarter, raising the vacancy rate to 21.5%. The amount of total office inventory that is being marketed for lease was unchanged quarter-over-quarter at an availability rate of 26.0%. The difference between this figure and the vacancy rate reflects expected future move-outs. Space being marketed for sublease represents 6.0 million sq. ft., or 9.6% of the 62.9 million-sq.-ft. total availability figure. The Central Business District vacancy rate is at 25.9%, up 150 basis points from this time last quarter at 24.4%, while the Energy Corridor vacancy rate is at 24.6%, down substantially from 27.3% in Q4 2019. Tenants Transocean, Bank of America, Honeywell and Engie all assisted in lowering the amount of vacant space in Houston in the previous fourth quarter to end 2019.

Office development

Office construction is at 3.4 million sq. ft across 20 buildings, with 2.0 million sq. ft. (58%) available for lease. The Central Business District and Galleria/West Loop, account for 1 million sq. ft., or one-half of the total space available. Hines’ Texas Tower is expected to deliver in late 2021 and is 40% preleased. Outside of downtown, of the 930,000 sq. ft. underway in the Katy Freeway East submarket, the 190,000-sq.-ft. building at 9753 Katy Freeway is being built with 85% of the space available for lease. Other office buildings under construction in the submarket include Marathon Oil’s 440,000-sq.-ft. future headquarters in CityCentre, and Village Tower I & II 150,000-sq.-ft. office buildings at 9655 Katy Freeway at the former site of a Toys R Us. The Katy Freeway East market has a vacancy rate of 15.3% compared to the metro’s overall average of 21.5%.

Investment sales trends

Real Capital Analytics data reports quarterly office sales volume for Q1 2020 in the Greater Houston area at $414 million, down compared to this time last year at $539 million. The primary capital composition for buyers in 2020 was made up of 59.5% institutional and 33.2% private. For sellers, the majority was 36.0% institutional, 33.7% REIT/listed, and 24.6% private investors. While the pandemic has caused many deals to be placed on hold, one office investor in Houston has responded to the disaster by seizing an opportunity. CoStar reported that Belvoir Real Estate Group closed a deal in mid-

Net Absorption

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ons

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Direct Sublease

Construction by SubmarketTotal Under Construction: 3,403,231 SF

0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4

Sugar Land/E Ft Bend

Kingwood/Humble

Bellaire

Pearland/South

North Loop West

Katy/Grand Parkway W

Woodlands/Conroe

Galleria/West Loop

Midtown

Katy Freeway

CBD

Millions (SF)

Pre-Leased Space Available Space

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Direct Sublease

26.0%

Availability Rates

Quarterly Market ReportHOUSTON OFFICE | Q1 2020

Investment sales trends cont.

March to buy a 110,529-sq.-ft. Class B office building located at 7660 Woodway Drive in the Galleria/West Loop submarket at the intersection of San Felipe Street and Voss Road. Belvoir paid about $15.6 million, or $141 per sq. ft. to the seller, California-based Commerce Realty.

Houston leasing two hotels as COVID-19 quarantine sites

The City of Houston approved two 90-day leases for a total of 186 hotel rooms to be used for first responders and city employees who are not able to quarantine at home. Included are those who are quarantining waiting for test results, or those exposed to the virus. The city will spend $312,765 a month for the two hotels, or about $56 per room, per night. The initial lease terms last for three months and can be extended if necessary. One hotel is located on the Gulf Freeway near Hobby Airport, and the other is off the Northwest Freeway near Spring Branch. Harris County is looking at NRG Stadium, among other sites, for a possible location to stage space for quarantine, treatment for non-critical cases and for intensive care. The city is also searching sites for treatment, including a Kindred Hospital facility in the Heights.

Average asking rents

The Houston overall full-service average rates are at $29.33 per sq. ft., a decrease of $0.51 from $29.84 a year ago. Asking rates for overall Class A space are $34.69 and Class B are $22.34 per sq. ft. Rent growth has varied across Houston’s submarkets. Asking rents in the Katy Freeway submarket averaged $35.49 per sq. ft., which is 21% higher than the metro average as a whole and ranked number two among Houston submarkets as of the end of Q1 2020. Houston’s office market already sits at 21.5% vacancy, with even more space—both direct and sublease—likely coming available. In Houston, office tenants will arguably have more leverage than at any other time in history with regards to negotiating rental rates, terms, tenant improvements and concessions. However, since the market was already soft prior to the current situation, the relative impact to occupancies and rents may not be as devastating as would be expected.

Historical Average Gross Asking Rent

$35.42

$24.56 $22.41 $20.81

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HOUSTON OFFICE | Q1 2020

Quarterly Leasing Activity Over 100,000 SF

0.0 0.2 0.4 0.6 0.8 1.0 1.2

North Loop West

Southwest

FM 1960/Hwy 249

Greenway Plaza

Greenspoint/North Belt

Westchase

Katy Freeway

Energy Corridor

Galleria/West Loop

CBD

Woodlands/Conroe

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ons

($)

Rolling 4-Quarter Volume Quarterly Volume

Historical Investment Trends - Sales VolumeSource: Real Capital Analytics

MARKET OVERVIEWSubmarket Stats

Submarket Statistics (Total reflects Class A/B/C)

Total Inventory (SF)

Total Vacancy

(%)

Total Availability

(%)

Q1 2020 Net Absorption

(SF)

2020 YTD Net

Absorpiton (SF)

Q1 2020 Leasing Activity

(SF)

Under Construction

(SF)

Overall Gross Avg

Asking Rent ($/PSF)

Houston Market Total 238,567,164 21.5 26.0 -207,280 -207,280 4,412,913 3,403,231 29.33

Class A 127,717,532 22.2 28.0 207,297 207,297 3,104,013 3,254,540 34.69

Class B 96,493,203 22.3 25.2 -363,773 -363,773 1,230,389 148,691 22.34

Submarket Statistics (Total reflects Class A/B/C)

Total Inventory

(SF)

Total Vacancy

(%)

Total Availability

(%)

Q1 2020 Net Absorption

(SF)

2020 YTD Net

Absorpiton (SF)

Q1 2020 Leasing Activity

(SF)

Under Construction

(SF)

Overall Gross Avg

Asking Rent ($/PSF)

CBD Total 39,704,905 25.9 31.5 -297,454 -297,454 865,301 1,251,856 39.34

Class A 30,352,851 23.3 28.8 -272,151 -272,151 818,008 1,251,856 41.95

Class B 8,682,771 35.8 43.5 -38,894 -38,894 47,293 0 29.69

Bellaire Total 4,139,522 16.7 22.6 20,713 20,713 19,921 52,825 24.74

Class A 1,602,427 7.8 16.5 -1,766 -1,766 11,225 52,825 28.59

Class B 2,218,587 24.3 28.9 23,914 23,914 8,696 0 23.56

Energy Corridor Total 23,332,690 24.6 28.3 359,508 359,508 233,424 0 29.07

Class A 14,874,105 23.3 28.1 314,034 314,034 98,385 0 34.04

Class B 8,127,079 27.4 29.3 48,195 48,195 134,194 0 22.81

FM 1960/Hwy 249 Total 11,187,596 24.0 30.5 18,759 18,759 152,668 0 20.57

Class A 3,251,536 21.3 35.0 -19,893 -19,893 42,478 0 27.38

Class B 6,729,515 27.6 29.4 35,407 35,407 105,657 0 18.86

Galleria/West Loop Total 28,699,413 19.4 26.7 19,716 19,716 433,924 277,202 35.03

Class A 20,230,112 20.2 29.9 45,785 45,785 321,238 207,202 37.47

Class B 8,419,301 17.6 19.1 -26,198 -26,198 110,140 70,000 25.21

Greenspoint/North Belt Total 11,499,588 50.2 51.4 35,427 35,427 186,379 0 18.30

Class A 4,963,101 65.2 66.8 1,131 1,131 36,553 0 21.11

Class B 5,338,365 45.0 45.8 41,081 41,081 127,479 0 15.04

Greenway Plaza Total 10,798,893 17.8 22.4 38,905 38,905 153,046 0 34.93

Class A 6,688,440 20.0 25.1 72,383 72,383 114,066 0 33.06

Class B 3,693,313 14.9 19.0 -31,371 -31,371 34,743 0 29.11

Gulf Fwy/Pasadena Total 3,621,251 19.7 23.6 4,578 4,578 37,130 0 23.08

Class A 105,782 1.2 1.2 0 0 837 0 32.03

Class B 2,854,170 20.6 23.6 14,578 14,578 36,293 0 22.89

Katy Freeway Total 10,032,178 10.1 15.3 7,190 7,190 231,791 930,000 35.49

Class A 6,137,057 11.1 18.8 11,100 11,100 207,927 930,000 41.01

Class B 2,589,888 10.7 11.0 5,144 5,144 22,858 0 21.10

Katy/Grand Pkwy W Total 3,392,538 15.7 24.5 -13,371 -13,371 26,137 150,920 29.21

Class A 2,124,720 22.5 34.6 -1,220 -1,220 16,592 150,920 29.35

Class B 1,076,626 4.4 6.7 -12,133 -12,133 9,345 0 28.83

Kingwood/Humble Total 1,439,990 10.8 15.9 51,123 51,123 15,090 39,106 24.32

Class A 219,236 14.1 25.3 0 0 11,247 39,106 27.90

Class B 1,105,048 10.6 14.8 54,084 54,084 2,674 0 23.57

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Submarket Statistics (Total reflects Class A/B/C)

Total Inventory

(SF)

Total Vacancy

(%)

Total Availability

(%)

Q1 2020 Net Absorption

(SF)

2020 YTD Net

Absorpiton (SF)

Q1 2020 Leasing Activity

(SF)

Under Construction

(SF)

Overall Gross Avg

Asking Rent ($/PSF)

Medical Center Total 9,085,190 7.2 7.8 -18,024 -18,024 94,131 0 26.29

Class A 3,295,885 6.1 7.5 -8,470 -8,470 26,900 0 32.28

Class B 4,679,274 7.0 7.2 33,607 33,607 66,215 0 23.69

Midtown Total 5,839,095 13.3 16.6 -4,207 -4,207 78,926 322,344 29.63

Class A 2,219,879 15.0 14.6 -21,909 -21,909 37,591 322,344 35.70

Class B 2,965,290 11.5 18.4 8,131 8,131 36,890 0 24.81

NASA/Clear Lake/SE Total 7,759,144 16.5 18.1 12,114 12,114 81,047 0 21.22

Class A 1,986,533 13.8 15.3 6,627 6,627 0 0 27.86

Class B 5,121,437 18.3 19.8 9,762 9,762 78,875 0 20.01

North Loop West Total 4,494,763 19.8 20.9 47,231 47,231 127,830 114,349 25.17

Class A 1,188,544 32.3 35.9 16,142 16,142 57,999 114,349 28.65

Class B 2,840,552 16.1 15.3 33,763 33,763 69,020 0 21.85

Northeast Total 2,414,297 11.8 15.0 -25,549 -25,549 20,616 0 20.36

Class A 146,580 9.6 9.6 3,889 3,889 0 0 22.53

Class B 1,476,718 13.6 16.8 -27,160 -27,160 14,231 0 21.44

Northwest Total 4,093,316 19.5 23.6 58,903 58,903 42,787 0 17.09

Class A 797,877 29.3 32.9 36,970 36,970 19,530 0 19.01

Class B 2,411,282 20.9 24.1 13,942 13,942 23,257 0 16.56

Pearland/South Total 1,701,763 11.0 11.2 -16,871 -16,871 10,237 79,691 28.20

Class A 672,270 4.4 4.1 -2,230 -2,230 0 48,000 29.71

Class B 805,886 16.6 17.4 -14,714 -14,714 10,237 31,691 27.92

Southwest Total 11,881,731 19.6 24.2 46,890 46,890 152,579 0 16.49

Class A 1,586,913 27.8 29.1 38,584 38,584 36,907 0 17.72

Class B 8,079,667 21.3 26.4 13,456 13,456 97,405 0 16.62

Sugar Land/E Ft Bend 6,731,141 13.0 17.3 -19,138 -19,138 37,651 27,000 26.73

Class A 3,802,371 11.7 17.8 748 748 10,638 0 28.38

Class B 2,799,577 14.3 15.9 -31,886 -31,886 27,013 27,000 24.98

West Belt Total 5,365,291 24.2 27.0 -140,425 -140,425 46,106 0 24.85

Class A 3,568,375 24.5 28.4 -138,347 -138,347 40,395 0 27.39

Class B 1,684,287 23.9 24.7 -2,078 -2,078 5,711 0 19.58

Westchase Total 14,882,072 29.4 32.1 -216,668 -216,668 187,942 0 28.03

Class A 8,057,049 32.3 34.0 -137,766 -137,766 121,526 0 34.59

Class B 6,648,113 26.5 30.5 -74,927 -74,927 61,373 0 21.96

Woodlands/Conroe Total 16,470,797 15.3 20.7 -176,630 -176,630 1,178,250 157,938 31.58

Class A 9,845,889 13.3 20.7 263,656 263,656 1,073,971 137,938 33.70

Class B 6,146,457 19.0 20.3 -439,476 -439,476 100,790 20,000 30.31

Suburban Total 198,862,259 20.7 24.9 90,174 90,174 3,547,612 2,151,375 26.82

Class A 97,364,681 21.9 27.7 479,448 479,448 2,286,005 2,002,684 31.91

Class B 87,810,432 21.0 23.4 -324,879 -324,879 1,183,096 148,691 21.52

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HOUSTON OFFICE | Q1 2020

Information and data within this report were obtained from sources deemed to be reliable. No warranty or representation is made to guarantee its accuracy.

90

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West Park Houston Tollway

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Fort Bend Tollway

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MARKET OVERVIEWHouston Office Submarkets

1. CBD

2. Bellaire

3. Energy Corridor

4. FM 1960/ Hwy 249

5. Galleria/West Loop

6. Greenspoint/North Belt

7. Greenway Plaza

8. Gulf Fwy/Pasadena

9. Katy Freeway

10. Katy/Grand Pkwy W

11. Kingwood/Humble

12. Medical Center

13. Midtown

14. NASA/Clear Lake/SE

15. North Loop West

16. Northeast

17. Northwest

18. Pearland/South

19. Southwest

20. Sugar Land/E Ft Bend

21. West Belt

22. Westchase

23. Woodlands/Conroe

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HOUSTON OFFICE | Q1 2020

Quarterly Market ReportAPRIL 2020

NAI Partners Houston Office 1360 Post Oak Blvd., Suite 1900 Houston, TX 77056

tel 713 629 0500

www.naipartners.com

Leta WausonDirector of Research

leta.wauson@naipartners.comtel 713 275 9618