With just over half of all Houston office space occupied by energy or engineering companies, the vitality of the energy market is always a primary concern for the office market’s health and maintaining occupancy rates. As evidenced by the negative cash flows of major publicly traded energy corporations, the plunge in oil prices that commenced in late 2014 cannot support or sustain the industry. Although the price of oil may have finally found a floor – oil prices hovered between $35 and $40 per barrel for much of Q1 – there is no recovery in sight for the energy industry. U.S. oil producers continue to rapidly curtail operations. The North American rig count sank to 450 by the end of the first quarter; according to Baker Hughes, this was the lowest count since tracking began in 1949 and marked an ominous drop of 56.2% from a count of 1,028 just one year prior.
Data via CoStar and the Federal Reserve Bank of St. Louis
Maintaining an oil price floor is pivotal in order to avoid an acceleration of weakening in the office market. However, the floor will likely be tested as equity markets remain turbulent and investors implement varying long- and short-term strategies that can spur fluctuation. The weakness in the energy market is a two-sided affair; above and beyond the supply glut, the economic slowdown in China and other emerging markets continues to curb demand. Additionally, even as they scramble to shut down rigs U.S. oil and gas producers can not control pricing in a world of excess supply - they are ultimately price-takers rather than price-setters.
OPEC hinted at cooperation to reduce oil production in Q1, and perhaps as a result the price floor was set in Q1. It’s not clear whether the upward price trend seen in the last few months will be sustained or not.
The price of oil is a leading indicator for office space in the Houston market. It will take more sustained growth in the price of oil to reverse the energy sector’s downsizing trend. There’s considerable sublease and shadow space in the Houston office market, so I expect the Houston office market to remain soft in the near term.
Leasing at 10-Year Low
Landlords in Houston increasingly find themselves as well in a situation of no longer being able to set pricing. Demand for office space plummeted to new lows in the cycle. First quarter leasing activity only amounted to 1.56 MSF of signed deals, the lowest quarterly volume in more than a decade. Direct vacancies, an office indicator that lags the market, stayed relatively flat during the past quarter. Available sublease space is a more immediate barometer of the office market, and more than 1.0 MSF in new listings has boosted the sublease availability rate soar during the past three months. Available sublease space jumped quarter-over-quarter from 7.69 MSF to 9.16 MSF, a 19.0% increase boosted by new sublease blocks from Shell, Marathon, BHP Billiton, and Apache.