Newsfeed: Houston, Dallas lead the country in office attendance — and empty office space

By Dani Romero via Yahoo! Finance

Landlords in Houston and Dallas are having a tougher time filling their empty office buildings with new tenants than any other market in the country, according to office market statistics compiled by CoStar and JPMorgan.

Why? One reason: They overbuilt when interest rates were low.

Houston and Dallas put up more new office space between 2010 and 2021 than all regions except New York. Despite the disruptions of the pandemic, they still have millions more square feet under construction. Vacancies now are higher than any other metro area, despite attempts to fill the gaps with heavy discounts.

Houston and Dallas had 18.8% and 17.2% of office space sitting empty at the end of 2022, according to the figures from CoStar and JPMorgan, well above the national average of 12.5%. New York, San Jose, San Francisco, and Chicago had vacancy rates of 12.3%, 12%, 16.4%, and 15.1%, respectively.

Where Houston and Dallas perform better than other big cities is convincing employees to return to their offices instead of working at home. Worker attendance in buildings monitored by Kastle Systems was more than 60% in Houston and more than 50% in Dallas during the week ending April 5. Those were higher than New York, Chicago, San Francisco and San Jose.

Office space occupancies in major US cities (Provider: Kastle Systems)

The challenges of these two cities illustrate the uphill climb facing even the strongest commercial real estate markets as landlords struggle to adapt to hybrid work arrangements and rising interest rates. Office space is sitting empty across the country as borrowing costs rise, building values drop, and bank lending standards tighten.

And all of these pressures give landlords even less room to breathe as they try to refinance a mountain of loans. In Houston, roughly $1 billion in outstanding commercial mortgage backed security loans secured by office properties are coming due this year, according to data from CoStar. Dallas has $334 million in such loans maturing by the end of 2023 and another $797 million in 2024.

“Refinancing risk over the near term is high and it’s gonna be really tough because interest rates are so high,” Itziar Aguirre, CoStar’s director of market analytics for Houston, told Yahoo Finance. “There’s gonna be a lot of foreclosures. I think there’s gonna be bankruptcies. There’s gonna be a lot of distressed sales.”

Texas boom and bust

Houston and Dallas have long lived with double-digit vacancy rates as the result of several booms and busts over the decades as the local oil and gas industry seesawed.

Vacancies began surging last decade when a plunge in oil prices roiled local employers in 2014, 2015, and 2016. The pandemic applied more pressure when companies emptied out their buildings and sent their people home.

And developers in Houston and Dallas didn’t stop building, even during the pandemic. Dallas still has more than 7 million square feet of new construction projects underway, while Houston has 5.3 million square feet, according to data from CoStar Group.

Even though Texas has added jobs faster than the overall economy since the pandemic, analysts don’t see this robust labor market fixing the real estate overhang in the state’s biggest cities.

“We do not expect these job gains to materialize into additional office demand at this time, as we believe corporations are still in the midst of re-evaluating headcount and office needs,” Nicholas Thillman, senior research analyst at JMP Securities, wrote in a note.

‘It’s going to continue to be a headache’

Between 2010 and 2021 the Dallas and Houston metro areas put up 48 million and 46 million square feet of new office space, according to 42 Floors, more than any other place in the country except New York City. They were No. 1 and No. 2 when counting all commercial real estate construction during that period.

Their biggest challenge is selling tenants on the older space put up during previous booms decades ago. Newer buildings that were built five years ago or less have single-digit vacancy, according to Aguirre, while older space from the 1980s is a much harder sell.

“There’s not a ton of prime space,” said Bill Kitchens, director of market analytics at CoStar Group. “We really do have to look at the configuration, the quality of the space, all those considerations that the tenants are still focused on.”

Some landlords are turning to discounts on space that can be subleased from tenants who downsized or ditched their office space for newer digs. In Houston, office subleases are being discounted by 25%-60%, according to CoStar.

“The discounts out there really haven’t moved the needle, that’s the long and short of it,” Kitchens added. “It’s going to continue to be a headache not only for our market, [but] major markets in the U.S.”