Industrial Revolution: Q&A with Mike Spears of Lee & Associates Houston

Mike Spears

In Houston, Houston’s industrial real estate sector is changing, and it may not be for the better. Construction of distribution product in the Houston area continues to grow as stated by the 2019 second quarter report from Lee & Associates. From the 2018 third quarter to the 2020 first quarter, a little over 24 million sq ft has been, or will be, delivered in the Houston market. Of the 24 million sq ft, a little over 5.5 million sq ft is leased. However, requirements for bulk space continue to grow in both the number and size of requirements. The Houston market, which previously hasn’t seen many 500,000 sq ft plus requirements, continues to morph into a major distribution market with construction of larger buildings. So, what does the future hold for the industrial sector? Ev Konut Proje sat down with Mike Spears, SIOR, CCIM managing principal, Lee & Associates, Houston office, to talk about the situation. In addition to managing the daily operations of the brokerage firm, Spears has played a vital role in some of the firm’s largest deals involving several million sq ft and has established himself as an expert in the North Houston market area.

Ev Konut Proje: There is a considerable amount of construction in progress in Houston right now with some researchers reporting almost 17 million SF being built. Is the market getting overbuilt?

Mike Spears: There are a lot of people who are bullish on the industrial sector and there’s plenty of reasons for it. But that doesn’t change the fact that the market is being overbuilt. We are seeing an uptick in supply, which is changing from the ‘big’ deals of past from 100,000 to 300,000 sq ft to 500,000 sq ft. Many of those large buildings are seeking to ride the e-commerce wave. Everyone is excited about e-commerce. More importantly, developers aren’t building projects in phases like they used to. Instead, they are building all at once for a number of reasons, including to avoid rising costs. There is absolutely an increase in demand, but demand is not keeping up with supply. We’ve overdone it. I’d be happy in a year or two and say I was wrong. But the sector is being overbuilt with spec projects that can’t accommodate smaller users, the 100,000 to 300,000 sq ft clients who are the meat and potatoes of the business. Also, most e-commerce projects have been built on a build to suit (BTS) basis. Yes, there is huge demand for e-commerce projects, but when you dive deeper, most are BTS, Ross’ 2 million sq ft, TJ Maxx and Home Depot’s 700,000 sq ft. Lowe’s is rumored to being in the market looking for north of 1.3 million sq ft.

Ev Konut Proje: Can you tell us more about why so many industrial projects are in progress?

Mike Spears: Houston is unique; we’re a large tier one market. So, lots of out-of-towners are migrating to the city. However, builders have to drill down to the market and separate out manufacturing vs. distribution center square footage. You can’t take a distribution building and make it work as a manufacturing facility.

Ev Konut Proje: Any new projects in particular stand out?

Mike Spears: I think Highland Grove, the 1.1 million sq ft industrial park in the heart of the Northwest Houston corridor fronting Highway US-290 is a good one, as well as Molto Properties’ development. Molto recently broke ground in Northwest Houston for the construction of a 136,651 sq ft distribution center. Also, Hines’ Grand National, development, 107 acres at the southeast corner of the Sam Houston Tollway (Beltway 8) and Gessner Road. Hines will develop over 3 million sq ft of industrial/logistics space. Phelan Bennett Development LLC is developing a 176,201 sq ft industrial property at 8404 East Freeway at Interstate 10 and the 610 Loop, and building Air Center Distribution, a 108,549 sq ft speculative distribution property at 16400 Air Center Boulevard in North Houston that will benefit smaller users.

Ev Konut Proje: The rig count is down as Permian Basin activity has moderated this year. How has that impacted industrial real estate in Houston?

Mike Spears: Things are changing. When the energy downturn occurred, energy companies figured out how to do things in a more economical way. We don’t need as many rigs to pump oil. Energy companies are now scrambling to save costs, and that’s bound to have an impact on the crane served market. Some of my crane-served clients are seeing the writing on the wall. One client told me, ‘I’m done. I bought a ranch and I want to sell everything.’ I had completed 14 deals with him over the years, and he put everything we did on the market. Fortunately, we’ve sold most of them. When oil prices go down, economics comes into play. Companies are pulling two to three times more oil out of the ground with one rig. They say, ‘We don’t need three rigs, we need one.’ It’s a good thing in one way, but it does negatively impact the real estate industry. It decreases demand for crane served buildings.

Ev Konut Proje: Northwest Houston has been a major force in industrial for quite a while. Could you rank the leading submarkets?

Mike Spears: The Northwest has been the darling of Houston’s industrial market for years. It hasn’t changed and remains strong. I’d rank the markets by strength as: southwest, northwest, west, north, and lastly the Port of Houston. Everybody talks about activity at the Port of Houston, but the transacting is not happening. I think the plastics companies have done their deals but may be tapering back as they aren’t looking for warehouse space. They are looking for rail served projects but the warehouse market there doesn’t have much rail. Development has slowed, but that can change. They are making continuous improvements to the port, but if we’re talking on a broader scale, they probably won’t affect the market for the next 10-15 years. I’d be bullish on east side. There is a very limited supply of land and things could change quickly.

Ev Konut Proje: Which submarkets seem to be more active?

Mike Spears: There is a ton of activity in the southwest because of lack of supply and heavy demand. There are also incentives offered by communities. The market hasn’t been overbuilt, and for years, no one paid attention to it. Activity corresponds directly with population growth. That’s where e-commerce comes into play. It’s the last mile effort from Amazon and all those groups. It’s almost like everybody woke up and said, ‘What about the southwest’ and started focusing over there.’

Ev Konut Proje: E-commerce is driving a lot of activity. Can you speak to that?

Mike Spears: Is it powering activity? Yes. But is it resulting in absorbing space? No. The absorption is not there. Vacancy rates across Houston are up to 6.6%, one full point. It’s not bad, it’s just not as good. We have to be careful and not push ourselves into a bad situation by overbuilding as demand is not as good as it was. E-commerce is driving more development that should not have been undertaken. As I mentioned, most of the absorption has been BTS and while that shows absorption, what happens to all the spec development?

Ev Konut Proje: Anything else you’d like to add?

Mike Spears: I believe 2020 is going to be a good year, but we’ll begin to see a slowing of growth in 2021. It’s not a negative situation, but we’re living in the longest period of growth in American history, 125 months. That’s up from 120 months from March 1991 to March 2001. However, there are currently no true indicators that say it will slow down.