Nat Holland Holland says the bottom depth is being driven by oil company vacancies of class-A products.

HOUSTON—Houston is well into the falling phase of its office market cycle, a market environment which favors tenants and buyers over landlords and sellers. The current falling phase of the office market began in early to mid-2014, prior to the oil downturn. Nevertheless, the falling office market has been greatly exacerbated by the downturn in the energy industry, likely leading to a deeper bottom than might otherwise be recorded, according to NAI Partners Data Insight, a forecast report of office vacancies.

In particular, there is a drastically softer class-A market than class B, as large amounts of class-A space are being vacated by oil and associated service companies. NAI uses office vacancy to examine Houston’s office market cycle, including forecasts of how deep the bottom may be and how differences may manifest among class A, B, and C buildings.

In examining current and historic vacancies of class A versus class B versus class C office buildings from 2000 through August 2016, increases in vacancy equate with a falling market and decreases in vacancy equate with a rising market. The cyclic behavior of the office market includes rising, peaking, falling and bottoming vacancies, which has been repeated in Houston for class-A and class-B buildings from 2000 to 2007 and 2007 to 2014, but not in class-C buildings, vacancies of which tend to be more stable (mean 9.4%, range 8.8 to 10.4%). In the past two years, however, there has been a strengthening of the class-C market, in which vacancies have steadily creeped down from 9% to a current 17-year low of 7.4%, according to NAI’s data.

In the current falling phase of the office market cycle, class A vacancies have increased from 9.7% to 16.5% in third quarter 2016─much higher than class-B buildings at 14.1% and representing a pattern similar to the 2000 to 2007 market cycle. NAI Partners’ statistical forecasts show that class-A buildings have the potential to trend upwards of 19% in the coming two years, while the class-B market will fluctuate modestly around a bottom of 14 to 15%.

However, the forecast for Houston as a whole is less dramatic, as the horizontal trend of class-B buildings stabilizes the vertical trend of class-A buildings, whereby overall office vacancies climb from the current 15.3% to the low- to mid-16% range. In a worst-case scenario, if all occupied sublease space turned to direct vacant space overnight, the resulting vacancy would be 17.9%. In either case, class-A vacancies will likely remain well above class B, indicative of a substantially softer class-A market. This can lead rents of class-A buildings to decline to the point where class-B tenants may become class-A tenants.

Nat Holland, chief research and data scientist, NAI Partners, tells “Although Houston’s office market began its falling phase in mid-2014 prior to the oil downturn, the pullback in the energy industry will contribute substantially to Houston’s office vacancy bottoming near 18% in late 2017 or early 2018 when the rising phase of the market cycle will then begin. The depth of this bottom is being driven largely by class-A products vacated by oil and oil service companies. If class A softens enough, tenants in class-B products may be able to negotiate their way into class-A buildings.”