Low Oil Prices Threaten Office Sector in Houston

Low Oil Prices Threaten Office Sector in Houston

Though it’s good news for consumers, the recent drop in oil prices to less than $50 a barrel threatens to derail the success of some of the nation’s office markets.

The stock market drop by 331 points on Jan. 5, as crude oil dipped below the $50 a barrel mark, showed the nervousness about a possible slowdown in U.S. economic growth. According to two recent studies, by commercial real estate services firms CBRE and JLL, energy firms will reconsider their investment appetites this year, and may be forced to cut back on capital spending and exploration budgets. The low prices will affect energy firms of every size, as large companies bleed profits and small firms can be forced into distress.

Lauren Picariello, national director with JLL’s research division, says that Houston enjoyed the most growth in its office sector in the past few years due to its large energy market, and is now the most exposed to risk. More than half of Houston’s class-A CBD stock is occupied by energy-related tenants. The city has seen office rents grow 19 percent since 2012—more than twice the national average.

“The question isn’t ‘will the Houston office market be impacted?’—it will—, but how great will the impact be? A large construction pipeline is putting more pressure on supply and demand fundamentals as well,” says Pacariello.

“I don’t think there is reason to panic,” she adds. “Considering the level to which Houston has outperformed the rest of the country, it can soften and still be regarded as a relatively healthy market.”

Energy firms won’t be immediately affected by falling oil prices, as most rely on long-term planning to support exploration and production activities and are loathe to lay off highly-skilled engineers, according to a recent report by Sara Rutledge, a director of research and analysis for CBRE. Oil prices would have to remain below break-even levels of $60 to $80 per barrel for an extended period of time to impact existing products. However, the lower prices have led firms to project for flat budgets in 2015, Rutledge says in the report.

Jonathan Brinsden, CEO of Houston-based real estate investment and development firm Midway, said at a recent conference that the city will likely see office vacancy rise in 2015 if oil prices stay below $60 per barrel. The city already has the most office development in the entire country, with 17.8 million sq. ft. of new construction underway. The Energy Corridor alone accounts for about 40 percent of that figure, with 16 new buildings being developed.

“Now we may see a different dynamic, with leasing in smaller chunks, meaning it will take longer to absorb the space,” Brinsden said.

Other markets more protected

Picariello says the shale regions of the Dakotas, Pennsylvania, Colorado and other pockets around the country won’t be as affected, as office markets in those areas haven’t expanded as much. Instead, those markets have seen a build-up in warehouse, storage and industrial product, along with residential and retail properties to accommodate the surge in population in these historically under-populated areas.

“Owners and developers of this real estate will be impacted if prices remain low long-term and energy companies are forced to shut down or reduce production,” according to Picariello.

However, low oil prices may have a minimal effect on the broader economy. The energy sector has already added about 240,000 jobs since 2010, and the recovery in the office sector has become more diversified, with technology and professional services companies also in expansion mode. Most major markets are seeing low vacancies, due to high demand and a lack of new supply.

While energy sector troubles may scare investors in places like Texas, in the rest of the country it will serve as an economic stimulus to consumers and a tax break to companies that consume lots of fuel, like airlines and e-commerce sites.

“The impact of low gas prices on consumers has not been felt in the broader economy yet, but as discretionary spending increases there are benefits for the broader office market and industrial markets,” says Picariello. “This trickle-down effect takes time, however. So prices need to stay low for a while for office and industrial to benefit.”

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