Enron collapse rattles Houston office market

HOUSTON — The financial collapse at Enron has major repercussions for the energy capital's commercial real estate community. The once mighty energy trading giant — which accounts for 10% of downtown Houston office space, or approximately 3 million sq. ft. of Class-A space — filed for U.S. bankruptcy protection in December and faces a congressional probe stemming from accounting irregularities. The company also has laid off 4,000 workers.

Serious doubts about the company's future have prompted local real estate analysts and brokers to predict that vacancy rates will rise sharply in Houston's Central Business District [CBD].

In addition to its 1.25 million sq. ft., 50-story headquarters at 1400 Smith, Enron occupies 500,000 sq. ft. in 3 Allen Center, 60,000 sq. ft. in 500 Jefferson and 40,000 sq. ft. in 600 Jefferson — all downtown.

Meanwhile, work on the Enron South Building, a new 1.2 million sq. ft., 40-story tower located at 1500 Louisiana, is nearly complete. The new Enron building is owned by an Enron entity. It boasts four, 55,000 sq. ft. foot transaction floors that feature 14-foot ceilings and are able to accommodate 500 transaction desks. According to county records, Enron's headquarters building is owned by Brazos Office Holdings II Ltd., which Houston real estate brokers believe is one of Enron's more than 3,000 partnerships.

The question on everyone's mind now is, “Who will occupy the new building?” Because of Enron's financial predicament, it's all but certain that the company will not move in, and surplus space will be added to the CBD.

Derrell Curry, senior vice president in the Houston office of CB Richard Ellis, says there is “no question” that vacancy in the CBD, currently about 4%, will tick up to about 9% this year. Brokerage experts further estimate the vacancy rate could rise to 14% to 15% if Enron's new building remains vacant, and could jump to 20% if both the new tower and its headquarters are abandoned.

Curry adds that these vacancy rates downtown would “not be the end of the world. Houston has lived through much worse. Four million sq. ft. of available space downtown in a total market of more than 143 million sq. ft. [in metropolitan Houston] is a small bump.”

Meanwhile, three other major office buildings are currently under construction downtown:

  • Fort Worth, Texas-based Crescent Real Estate is building 5 Houston Center, a 27-story, 577,000 sq. ft. skyscraper scheduled to open in the third quarter. The new tower is in the existing Houston Center complex, which contains more than 3.1 million sq. ft. Ernst & Young, which has been housed in Houston Center since 1988, is one of the lead tenants in 5 Houston Center, having committed to a 10-year, 118,000 sq. ft. lease. Other tenants include Jackson Walker, which has signed up for a 67,000 sq. ft. lease, and Cap Gemini Ernst & Young, which has leased 46,000 sq. ft. The building is 74% leased.

  • Houston-based Hines, in partnership with locally based Prime Asset Management, has broken ground on the 32-story, 689,000 sq. ft. Calpine Tower, which is scheduled for completion in the fourth quarter of 2003. Calpine Corp. has leased 300,000 sq. ft. of the structure.

  • Houston-based Century Development is building a 1.3 million, 36-story office tower at 1000 Main. C. Richard Everett, chairman, CEO and majority owner of the firm, says the $150 million future home of utility Reliant Resources will include a trading floor on top of the 10-story parking garage. The building is 80% leased.

Timing is everything

When the buildings were planned, downtown occupancy rates for Class-A space were at historically high levels, with the demand for quality office space growing, notes Jane Page, senior vice president of asset management and leasing for Crescent's Houston office.

“Downtown occupancy was 97%, so more space was needed to accommodate existing tenants,” she says. She adds that Houston's growth industry downtown is power trading companies, which will likely be interested in occupying at least part of the new 40-story Enron tower if the troubled energy company doesn't move in.

“We've heard that there are large users in Houston and outside the city that have been looking at the Enron space,” says Page. “The positive aspect about it is that it's a completed building — with the world's greatest trading floors. And a company relocating to downtown or moving here from another city could move into the space immediately.”

Everett of Century Development says that various parties are ready to bid on the new Enron building, including Century. “Obviously, the vacancy is going to go up if that Enron space comes up,” says Everett. “But there is an incredible overreaction. There will be a shift in perspective over the next six months.”

Everett says his company's ability to pre-lease 80% of the 1000 Main building, the largest tower now under construction in the city, is a good sign for the CBD. “I think the reaction over Enron is a large overreaction. We're talking about 4,000 jobs lost, and that's not good. But in the 1980s, Houston lost 250,000 jobs. That was a serious setback. This is a serious blip.”

With the lead tenant signed on to occupy nearly half of Calpine Tower, Hines is confident that nearly all of its building will be leased prior to its fall 2003 opening. Hines is in negotiations with two other parties interested in leasing in excess of 50,000 sq. ft., says George Lancaster, vice president of corporate communications at Hines.

Concern mounts over rising vacancies

Although three of the large buildings under construction are significantly pre-leased, the local real estate community is concerned that Enron could vacate large amounts of office space, including the 50-story headquarters building it currently occupies downtown.

“If Enron dumped more space on the market, the vacancy rate could soar,” says Richard Zigler, research director at O'Connor & Associates, a Houston-based real estate and research firm.

Due to the surplus of office space, Trammell Crow Co. of Dallas temporarily shelved plans for Ballpark Place — a 36-story structure that was scheduled to include retail space, apartment units and 280,000 sq. ft. of office space.

“As a result of Sept. 11 and the Enron situation, getting a project of that magnitude financed was not going to happen right now, so they pulled the plug,” notes David Cook, senior director at Cushman & Wakefield of Texas Inc.

However, Cook adds that regardless of how much office space Enron dumps on the office market, the company's problems will not be the “death knell” of the downtown office market. “Downtown had a whole lot of momentum going for it before the Enron setback,” Cook says. “Those business units of Enron that are still viable are going to land somewhere, and they are going to need office space.”

The prospect of a vacancy rate of 15% or higher is worrisome, but it wouldn't be disastrous, adds Zigler. “While this would be extremely unpleasant for the downtown office market, this has been the tightest submarket in the city for the past year and the shock would not likely prove catastrophic,” says Zigler. He adds that the 96.8% occupancy rate for Class-A office properties downtown is the strongest in the metro area.

Strong local economy

In spite of the recession, the Houston real estate market remains one of the strongest in the nation due to the strength of the city's energy sector. According to the Texas Workforce Commission, the unemployment rate in Houston in December 2001 was 4.4% compared with 5.4% nationally. In addition, the city is reporting its highest multifamily occupancy in decades. And while job growth has slowed, Houston expects to create some 23,000 jobs in 2002.

David Loftus, a prominent Houston financial consultant who recently purchased a seventh parcel downtown for possible future development, says pessimism is running rampant in the wake of Enron's troubles.

“It's like Sept. 11. Everyone predicted depression and doom and gloom,” says Loftus. “But the markets came back. So all of these predictions on the negative side tend to be for the short term and wrong.”

Zigler adds that the past year has been particularly unkind to Houston. “From a record flood to a record bankruptcy to a nationwide recession, misfortune has struck Houston with a ferocious wallop,” he says. “As we look to the remainder of 2002, one is tempted to proclaim that things can only get better.”

Mike Sheridan is a Houston-based writer.

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