Low gas prices make just about everyone happy—except those in the oil industry and the economies that rely on them. Experts say that office markets that rely on energy firms, which coasted on neutral this year as oil supply increased and prices dropped, will suffer in 2016 through a period of higher vacancy and sinking lease rates.
Oil prices sunk below $40 a barrel this week, and there doesn’t seem to be a hike in sight. U.S. inventories of crude oil, bolstered by fracking and efficiencies in the energy industry, increased for the 10th straight week and the Organization of Petroleum Exporting Countries (OPEC) has also raised oil output to try to compete. The OPEC nations, meeting on Friday in Vienna, are not expected to reduce production.
Jessica Ostermick, director of research and analysis at commercial real estate services firm CBRE, says fears of falling oil prices causing widespread fallout for the commercial real estate industry proved largely unrealized in the top U.S. office markets in 2015. While subleasing increased in cities such as Houston, Texas, regions with diversified economies such as Denver didn’t feel much of a pinch. Next year is a different story, she says.
“Looking into 2016, I think we’re going to see amplified impacts in energy-heavy economies,” Ostermick says. “Oil companies will start letting employees go and look for efficiencies. After 18 months of lower oil prices, they’re going to hit their limit [in how long] they can go forward without making changes to the real estate footprint.”
Houston, the U.S. energy capital, will likely suffer the most. The market that saw a huge boom following the recession, as energy competed with the tech sector for the most robust job growth, is now seeing a corresponding fall as oil prices drop. Commercial real estate services firm Transwestern, which is based in Houston, announced during its recent Houston Trendlines event that the city has now become a tenant-led market.
According to Transwestern predictions, Houston’s office leasing will remain slow in 2016, and demand will likely be lackluster. Overall vacancy has increased from 9.9 percent at the end of the third quarter 2015 to 13.0 percent today. Available sublease space has risen from about 4.1 million sq. ft. in the third quarter of last year to about 7.3 million. Also, the construction boom that began as a response to the post-recession demand is now in full-swing, with more than 10.1 million sq. ft. of office space under construction, with a significant lack of leases signed in those planned properties.
“It’s anticipated that the overall vacancy rate for all classes of space will increase during the next two years, climbing to the mid-16 percent range,” according to a statement from Transwestern following the firm’s event. “For the same reasons, Houston’s strong net absorption and rental rate growth should begin to taper off and flatten out in the period ahead. The office sector will continue to experience softness and move into the tenant’s favor while the current economic conditions persist.”
However, Ostermick says in 2016, the energy slump should still only affect those office markets that have not diversified. Dallas and Denver, for example, are seeing tenants from other industries, such as health care, move into both existing and new space. Also, the areas where fracking created new markets nearly overnight are not yet feeling hardship.
“The exploration markets, such as West Texas, Pittsburgh and in North Dakota, where there had never been class-A office buildings, there were boomtowns, where there was a significant imbalance of all property sector supply,” she says. “Demand has pulled back and developers have been able to deliver needed product. These companies are still producing. What we see now is a balancing out in those markets.”