$442M Hess Tower Buy Represents Houston Office

HOUSTON-Perhaps the most obvious symbol defining the office market this past year can be summed up in two words: Hess Tower. The 844,763-square-foot energy company’s headquarters recently sold to a Canadian REIT for a record-breaking $442.5 million, with experts telling Globest.com that this transaction was a strong indication of huge investor interest.

“The Hess deal, on its own, is a credit long-term lease; but a significant commitment to Houston on a price per square foot basis,” comments Ken Page, managing director with Transwestern. “But we’re seeing investors come back into the market to buy multitenant buildings, not on a distressed basis, but because real estate fundamentals are so good here.” Such activity, Page adds, is being seen among all classes of buildings, with investors ranging from national and international institutional funds to private buyers backed by equity.

The reason for the growth, comments Jones Lang LaSalle research manager Omar Nasser, is attributed to the energy companies. “Obviously office demand increases as energy companies ramp up operations,” he says.  During 2011, he goes on to say, Houston added around 80,000 jobs – in 2012, 84,000 more jobs are likely to come online.

David Hightower, chief development officer with Wolff Cos., notes that the jobs growth has meant that some companies are making moves to obtain more space because they’re bursting at the seams. Other companies that may not have to make those decisions immediately are putting them off until next year. “The companies are trying to grow, but it’s restrained growth because of external factors; the national economy being a significant one,” Hightower explains.

Furthermore, those fundamentals took some by surprise. Transwestern’s vice president Paul Wittorf, for example, acknowledges he entered 2011 “kind of cautiously optimistic,” believing that the real estate market was finally turning the corner. “But 2011 exceeded expectations,” he says. “We saw a decline in vacancies, an uptick in rental rates and 3 million square feet absorbed city wide.” Much of the absorption has been in the class A space though it’s likely that in 2012, more B space will be absorbed as well.

Nasser points out that quality space, especially in the CBD and the Energy Corridor, are seeing tightening. It’s those submarkets that are “at that point in the cycle where there’s not enough space and a lot of demand,” he adds.

Tim Relyea, vice chairman with Cushman & Wakefield of Texas Inc.  agrees that demand is certainly high – but it’s higher for the first-generation buildings (such as Hess Tower) that are being built. Those newer buildings, he explains, will have different costs which will, in turn, lead to different sales prices. Even so, the market for vacant space “is still very tight,” Relyea comments.

Despite the tightening space and interested investor community, however, the specter of masses of buildings going north isn’t likely to happen any time soon. Certainly, Relyea says, “we’ll see close to 20 new buildings come out of the ground, which is a lot, compared to the past 15 years.” A couple of projects are underway in the Galleria and Energy Corridor submarket, but Wittorf points out that most of those developments required a 60% prelease before groundbreaking. Furthermore, “we don’t see anything delivering until 2014,” he continues.

Nor are any of the experts seeing the frenzied overbuilding that took place during the 1980s. At that time, the climbing crane became the region’s main symbol, with glass and steel buildings going north at a breakneck pace. When the economy crashed, “a lot of see-through projects remained,” Hightower comments. Adds Relyea: “Almost half of Houston was built between 1980 and 1984. We don’t see that happening again.” He further adds that 90% of the buildings coming out of the ground are user-owned or pre-leased. However, in 2012, “there could be three to five spec buildings coming out of the ground,” Relyea remarks.  Hightower sounds a note of caution for spec development, however pointing out that underwriting standards for construction continue to be stringent.

Whether or not Houston sees buildings trading for $523.81 per square foot in 2012 as did the Hess Tower remains to be seen, though Transwestern’s Page believes that more investors will come into Houston seeking similar assets, and those investors run the gamut from private equity to institutional REITs.  The fact that a buyer is willing to break records to buy an office building speaks well for the investment community’s assessment of Houston. “It’s still not a ‘coastal city,’” Hightower comments. “But it’s not a second-tier city any more. We moved from persona non-grata coming out of the 1980s to being the place for investment capital right now.”

But experts are adamant that, for the most part, the same positive trends experienced in 2011 will spill over into 2012, though Nasser believes more sublease space will hit the market as well.  Still, the combination of increasing jobs and a lack of building delivery means that “during the next two years, we could see one of the healthiest office markets in Houston,” Wittorf predicts. 

Nasser agrees, but points out that what’s going on nationally – the election; and internationally – questions about the euro; could have an impact on the office market. “There is an uncertainty you really can’t ignore,” he adds. “I don’t want to be overwhelmingly optimistic or skeptical, but we need to be somewhere in between.”