Q1 Office Report Shows Owners Gain Control

Tenants once had a variety of spaces at reasonable costs to choose from, but accelerated demand and not much supply coming on line has changed things. In its first-quarter report, Grubb & Ellis Co.'s research team pegged vacancy at 14.3%, down 3% from Q1 2006 in the 158.9-million-sf inventory.

Class A space especially is tight, with only 8.9 million sf open in the 76.7-million-sf stock. There is 3.2 million sf of spec construction under way, but only 281,000 sf has made it to market so far.

"In the majority of the submarkets, it's a landlords' market," says David Lee, senior vice president for Houston-based Transwestern. "There are some areas performing magnificently and others maybe not as strong." The high-performing areas include the Galleria, CBD, Westchase, Woodlands and Energy Corridor.

Steve Biegel, a senior vice president for Studley in Houston, concurs that it's a landlords' market. He also points out that it's now become a challenge to find large blocks of contiguous space for tenants.

Biegel says main markets like the Galleria and Downtown had a lot of class A space before the last half of 2006. That and competing owners meant a credit tenant had pretty good leverage. "We saw that evaporate over the past half-year," Biegel says.

Large vacancies coupled with slow demand once meant building owners and managers were offering the moon to get tenants on board. These days, tenants are the ones shifting strategies. Lee points out tenants, in many cases, are negotiating leases well in advance of expirations and are doing their best to stretch them to longer terms.

Biegel adds other tenants saw the writing on the wall some years ago and took steps to expand and negotiate new leases while they could. "Sometimes you're just lucky and your lease expires at the right time," he says. "The people who had that opportunity from the first half of 2006 or even in 2005 or 2004 made deals that, based on current economics, look fantastic."

Lee predicts that with construction costs on the rise, replacement prices could boost rents above $30 per sf. As it now stands, class A, full-service rents hover $25 per sf and already are $27.32 per sf in the CBD. "The thought of $30-plus per sf rental rates might startle all of us in Houston, but someone with a broader, more national perspective may think differently," Lee adds. "We're still relatively affordable based on that."

Even with lease rates predicted to zoom higher, Biegel doesn't see tenants moving to get better deals elsewhere in the city. With the labor market tight, the business emphasis is on hiring and retaining qualified people. "There isn't a person I'm dealing with that doesn't want to make a good deal," he says. "But they won't move into an inferior, lower-quality building to save a few bucks. They know it would have a negative impact on their ability to hire and retain people."