Real Estate Close-Up: Houston

While the rest of the country withered under $4 a gallon gas, Houston and its commercial real estate market thrived.

Thanks to an economy heavily dependent on the oil and gas industry, the city's office and industrial market posted strong rental and low vacancy figures through the third quarter. But the choke hold on credit markets, a limping economy and falling oil prices could seep into Houston's seemingly resilient market.

"Houston so far is holding its head up," said Jim Gaines, a research economist at the Real Estate Center at Texas A&M University.

The city created about 55,000 jobs in the first eight months of the year and its unemployment hovers around 5.1 percent, compared to the nation's 6.5 percent. Five of the 10 fastest-growing companies are based in Houston, Fortune magazine reported this year, and all of them are related to the energy industry, most notably Atwood Oceanics and DXP Enterprises.

The office market posted a healthy 11.8 percent vacancy rate in the third quarter, according to CB Richard Ellis Inc., compared with a national vacancy of 14.1 percent. More than 608,000 square feet of space were absorbed during that time. Office rents are sitting at all-time highs of $23.38 a square foot with downtown rents rivaling those of major business districts in the nation.

Meanwhile, the industrial market's availability rate dropped to 7 percent, versus the national rate of 11.4 percent. About 2.4 million square feet were occupied in the quarter, the 22nd straight quarter of positive absorption. The effects from Hurricane Ike, which hit the city in September, are likely to show up in the fourth quarter. Buildings in Houston suffered little damage, but displaced tenants from nearby Galveston and surrounding areas may seek temporary leases in the city.

The fallout from the credit crisis also won't be reflected until the fourth quarter and beyond.

"Any time you're in a capital market crisis, there's indecision in corporate America. They postpone decisions. They back off from growth plans," said Dan Bellow, president of Jones Lang LaSalle Inc.'s Houston operations.

The retail sector is already showing signs of weakness as consumer spending slows amid dismal economic headlines and a bulk of new construction hits the market. Retail vacancy is between 14 percent and 15 percent, double the national rate.

Retail developers went gangbusters during the housing boom, building neighborhood strip centers to support the new residential communities. But when housing demand waned, retailers were reluctant to open new shops near half-filled neighborhoods.

The freeze on credit markets also curbed expansion plans for smaller retailers.

"Most shopping center tenants are small, entrepreneurial. Those businesses require debt to operate," said Randy Moore, Grubb and Ellis Co.

The lack of credit has also hurt investment sales just like in other cities nationwide.

"There's no capital for the investment properties and we have a lot of inventory on the market," Moore said. "We're seeing deal after deal evaporate with lack of available debt."

But the credit crunch has also stalled new construction, a healthy change in a city where commercial developers can be trigger-happy and build even when the market doesn't support it.

"I suspect there won't be any new commercial development for the next couple of years, unless you do all (cash financing) or have a source of funds willing to gamble with you," Gaines said.

The are only two major downtown offices on the horizon, each 1 million square feet and already in development. They will be completed in the next two years and could pressure rents there. As for industrial, construction has slowed because demand near the port hasn't been as strong as developers anticipated.

Apartment construction has also been robust, especially in the downtown area. Rental demand has remained steady due to solid job growth and a lack of mortgage availability which has shut out would-be homebuyers from the for-sale market.

Local real estate experts expect activity in commercial real estate to slow, but not contract in the next year. They estimate that 20,000 to 30,000 jobs will be created next year, though much of the outlook hinges on oil.

"If oil stays in the $50 to $60 range we'll be just fine, we just won't grow robustly," Bellow said. "If oil went to $15 a barrel, then believe me, Houston will slam on the brakes."

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