HOUSTON – (Realty News Report) – Houston’s industrial real estate market is undergoing significant change, and not all signs point to improvement. According to Lee & Associates’ second quarter 2019 report, distribution construction in the Houston area has surged. Between the third quarter of 2018 and the first quarter of 2020, just over 24 million square feet of industrial space has been delivered or is scheduled for delivery in the Houston market. Of that total, roughly 5.5 million square feet is currently leased. Meanwhile, demand for large bulk space continues to grow in both the number of requirements and the size of those requirements. Houston — a market that historically saw relatively few requirements above 500,000 square feet — is transforming into a major distribution hub with larger buildings under construction. To better understand these trends, Realty News Report spoke with Mike Spears, SIOR, CCIM, managing principal of Lee & Associates’ Houston office. In addition to overseeing daily brokerage operations, Spears has handled several of the firm’s largest multi-million-square-foot transactions and is a recognized authority in the North Houston industrial submarket.
Realty News Report: Many researchers are reporting nearly 17 million square feet currently under construction in Houston. Is the market at risk of being overbuilt?
Mike Spears: There’s a lot of enthusiasm around industrial real estate, and there are valid reasons for optimism. Still, the market is being overbuilt. We’re seeing a substantial increase in supply, with a shift toward much larger projects — buildings in the 500,000-square-foot range instead of the 100,000–300,000 level that dominated previously. A lot of these larger developments are aiming to capture e-commerce demand, and developers often build entire projects in one phase rather than in stages, in part to avoid rising construction costs. While demand has risen, it isn’t keeping pace with supply. Many speculative projects are not suitable for the smaller users — those 100,000–300,000 square-foot clients who form the backbone of the market. Also, much of the e-commerce-driven demand has been satisfied through build-to-suit (BTS) projects — for example, Ross’ two million square feet, TJ Maxx, and Home Depot’s 700,000 square feet. Lowe’s is reportedly seeking more than 1.3 million square feet. That type of BTS activity masks the fact that speculative inventory may struggle to find tenants.
Realty News Report: Why are so many industrial projects being developed right now?
Mike Spears: Houston is a large, tier-one market that attracts national and international investors. Many out-of-town developers see opportunity here. But it’s important to distinguish between manufacturing and distribution uses — a distribution building won’t always suit manufacturing tenants. Developers and investors need to be precise about product type and end-user requirements.
Realty News Report: Are there specific new projects you find notable?
Mike Spears: Yes. Highland Grove, a 1.1 million-square-foot industrial park fronting US-290 in Northwest Houston, stands out. Molto Properties recently broke ground on a 136,651-square-foot distribution center in the same region. Hines’ Grand National is another major initiative — 107 acres at the southeast corner of the Sam Houston Tollway (Beltway 8) and Gessner Road, planned for more than three million square feet of industrial/logistics space. Phelan Bennett Development is building a 176,201-square-foot industrial facility at 8404 East Freeway near I-10 and the 610 Loop, and an Air Center Distribution speculative project of 108,549 square feet at 16400 Air Center Boulevard in North Houston that is intended to serve smaller users.
Realty News Report: The rig count has dropped as Permian Basin activity has moderated. How has that affected industrial real estate in Houston?
Mike Spears: The energy sector has adapted to lower activity by improving efficiency; fewer rigs now produce more oil. That efficiency reduces demand for crane-served industrial facilities and other energy-related industrial space. Some long-time energy clients are exiting, selling portfolios they once expanded. When oil prices fall, companies consolidate and reduce their real-estate footprints, which in turn softens demand for specialized industrial product such as crane-served buildings.
Realty News Report: Northwest Houston has been a dominant industrial submarket for years. How would you rank leading submarkets now?
Mike Spears: The Northwest remains very strong and has been a consistent leader. Overall I’d rank the submarkets by strength as: southwest, northwest, west, north, and lastly the Port of Houston area. The Port is often discussed, but transaction volume hasn’t matched the conversation. Companies that relied on port-related logistics — like some plastics firms — have completed many of their deals and may be slowing new acquisitions. The port lacks widespread rail-served warehouse inventory, which limits some types of growth. While improvements at the port continue, broader market effects may take a decade or more to fully materialize. I’m optimistic about the east side too; land there is scarce and conditions could shift quickly.
Realty News Report: Which submarkets are currently most active?
Mike Spears: The southwest is very active, driven by limited supply and strong demand. Local incentives and historically limited development there have made it attractive. Activity often follows population growth, and with more households concentrated in the southwest, e-commerce “last mile” requirements have pushed developers and occupiers to focus on that submarket.
Realty News Report: E-commerce is frequently cited as a primary driver. How is it influencing the market?
Mike Spears: E-commerce is definitely powering development activity, but it’s not yet translating into proportionate absorption of speculative supply. Overall vacancy across Houston has increased to about 6.6 percent — up a full percentage point. That isn’t catastrophic, but it shows the market is loosening. We must be cautious about overbuilding, because current demand doesn’t match the aggressive pace of new construction. Much of the recent absorption reflects build-to-suit deals. The question remains: what will happen to all the speculative product if those BTS deals continue to dominate leasing activity?
Realty News Report: Any final thoughts?
Mike Spears: I expect 2020 to be a solid year, but I anticipate growth will slow in 2021. This isn’t an alarm — we have been in an extended expansion, the longest in modern U.S. history at 125 months at that time — but cycles do change. Today there are no definitive indicators signaling an immediate downturn, yet developers and investors should remain vigilant given the volume of speculative industrial construction under way.
Oct. 20, 2019 Realty News Report Copyright 2019
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