Industrial Services

Hot Markets: Houston’s Distribution Revolution

Justin Robinson October 15 6 min read

Houston, home to 4,600 energy-related companies, is often not surprisingly called the Energy Capital of the World, considering the city boasts an estimated 600 exploration and production firms, 1,100 oilfield service companies, and over 180 pipeline transportation establishments.

Of U.S. publicly traded oil companies, 44 out of 113 are located in Houston. But the City is about more than oil and gas. With global targets for fossil fuel reduction and a movement toward renewable energy sources, Houston’s high concentration of engineers and experienced energy professionals—plus a reported $3.7 billion in Cleantech Venture Capital Funding—means the region is well-positioned as an innovation hub to develop large scale renewable energy projects in solar and wind.

In terms of commercial real estate (CRE), we look at Houston with a broader view. The Houston industrial market is just over 716 million square feet, comprised of institutional and non-institutional quality (i.e., grade level crane-served/specialized manufacturing) facilities. The institutional side of the market reduces that tracked square footage nearly in half to 323 million square feet citywide.

Consumptive Demand and Accelerating Trends

Houston is often perceived as 100% energy-based. And while no doubt energy plays a major role, there are many more segments of the Houston economy that are not directly tied to energy.

The Houston industrial market is mostly influenced by consumptive demand—meaning anything you need to live, work, eat or play. All the things that go into building a house, buying groceries, and items you order online. These consumables are the drivers of Houston’s industrial market. Houston’s population is now more than 7 million people, the 4th largest MSA in the country behind Chicago, driving demand for goods and it is this derived demand that impacts the institutional side of Houston’s industrial market.

COVID-19 accelerated existing trends toward national growth in demand for industrial assets. Companies have revamped supply chains, and many companies have added to their e-commerce functions. Real Estate Capital Alliance reported that “In retail e-commerce (of physical goods), yearly total revenue increased by $71.55B in 2020 and is projected to increase by another $131.74B by year-end 2025 (Statista). This exponential growth is a great indicator of what’s to come in terms of industrial space demand. Before 2020 yearly growth averaged only $37.09B per year. To put this into perspective, e-commerce retail revenue grew 120% in 2020 even as the Covid pandemic put the brakes on the overall economy.”

Online businesses and traditional brick-and-mortar retailers alike have to offer their customers a convenient e-commerce platform to retain loyalty and gain new business. Houston has seen a huge growth in new entrants to the market, driven mostly by companies modernizing their supply chains to enhance proximity to Houston’s massive population, achieve port diversification, and to maximize their e-commerce reach and capability. The growing demand for products sold online and consumer expectations for speedy delivery impacts suppliers, manufacturing, and of course demand for industrial assets.

With 7 million people locally, plus reach within a 5-hour truck drive to upward of 16 million people (excluding Dallas/Fort Worth) from a distribution perspective—Houston is perfectly positioned to meet the demand for this evolving and growing consumptive demand.

There are some larger industrial markets across the country; Inland Empire, Dallas, Chicago, Atlanta, and the Lehigh Valley in Pennsylvania, which are classified as tier 1-A distribution markets. Even pre-COVID, businesses were revamping their supply chains to capitalize on e-commerce and omnichannel opportunities. COVID meant that businesses needed to fast-track those efforts. Stay-at-home orders and restrictions meant that people could not go anywhere—and many turned to online solutions for everything from food deliveries to workout equipment.

The 1-A markets were prioritized by businesses. Distributors made their bets and built out their distribution center networks in those markets first. Once those primary markets have dots on the map, the strategy expands to Tier 1-B markets like Houston to meet new demand and pressures being exerted in the new economy. As a result, Houston’s industrial product is experiencing higher tenant demand now than at any single point over the last 15 years.

High demand, coupled with shrinking supply and higher barriers to entry, such as the new floodplain restrictions, mean there are fewer viable development sites. Bisnow reported recently that competition for well-situated land along transportation corridors has become so fierce in Houston that industrial developers are paying 30% to 50% more for land than a few years ago. These factors, coupled with increasing commodity prices (steel, concrete, and roofing materials), are driving up construction costs. Costs that will eventually pass to end-users as demand continues to outstrip supply and drives market costs. Rent growth in the short to medium term is anticipated, due to these dynamics.

Developers are considering less obvious, more pioneering areas or more remote sites, which can impact the access to available labor. If a developer plans to build 1 million square feet, there are not many viable “plug-and-play” sites to choose from anymore. Identifying sites and assessing them for feasibility takes a lot of analysis and creativity in today’s environment. Developers new to the market who plan to build, are challenged because of those nuances.

It is an interesting phenomenon when 12 months ago Houston was perceived as an overbuilt market. Today and through the end of this year, that switch is flipped. As new deliveries to the market remain very measured (at least for the next 18 months), supply has become even more constrained and pre-leasing of new industrial developments is occurring in the most sought after submarkets. Currently, there are so few new construction options for tenants, that Houston is a fully landlord-driven market.

What’s Next for Houston?

As the pandemic accelerated the consumer trend for online shopping described by Bisnow as “on a scale never before seen in the U.S.”, demand for institutional-grade warehouses and distribution space has skyrocketed. Houston’s location as a transportation hub makes it an ideal to fill consumptive demand in the 1-B Tier space for distribution facilities. Transportation costs and many elements of the supply chain are linked to the energy market, but there is no doubt that the demand for consumable goods (excluding oil and gas) is the catalyst for Houston’s distribution revolution.

The overall outlook across most submarkets is that Houston will become further supply-constrained for new institutional-grade industrial product, independent of the oil and gas markets. As pre-pandemic supply is absorbed, and vacancy rates continue to fall, Houston’s industrial market will become even more appealing for investors, attracting developers to compete and pay higher land prices, increasing rents in the process.

Stream Meets the Demand for Industrial Space

After delivering phase one of the speculative industrial development, Empire West, in April 2021, just four months later the asset is 100% occupied. Empire West phase two recently broke ground in September 2021 to provide a further 2.3 million square feet across six new buildings.

While the institutional quality side of Houston’s industrial market is not correlated to the price of oil, it is tied to the consumer, and that consumptive economic machine is rolling fast, and we believe will continue to do so. Through the end of Q3 2021, the appetite for high-quality distribution space continues to improve the statistics for the Houston market. With record-setting positive net absorption, and overall vacancy decreasing quarter-over-quarter throughout 2021, Houston will remain a landlord market for the foreseeable future. However, developers are taking note of these improving statistics and will inevitably find a way to get buildings into production. While more challenging than in the past, typically time and money cure most development challenges in our market. That said, we see a dramatically undersupplied market over the next 18-24 months that will lead to meaningful rent growth and further tightening in the market. The big question is how long the run will last, a question nobody knows. We look to the Tier 1-A markets that are ahead of Houston to help predict our future. We have not seen any worrisome statistics to indicate we will see a slowdown in tenant demand in Houston any time soon. We believe it is the opposite, where Houston is early in the cycle for growth.  

Houston has seen massive growth in life sciences, hosting some 1,760 life science companies, the city is also home to the largest medical center in the world Texas Medical Centre. Houston ranks third among U.S. metro areas in Fortune 500 headquarters and has a good business climate for smaller businesses, local tech startups reportedly raised over $820 million in Venture Capital in ’20. When you think of Houston, think oil and gas, but also think life sciences, aerospace, digital technology, and innovation, think education, and remember that Houston has the largest export market in the U.S and that Port Houston is the largest container port on the Gulf Coast—so, as consumptive demand continues to rise, think of industrial assets and distribution.

Justin Robinson is a Managing Director & Partner in Stream’s Houston office. Justin oversees transaction services in Houston, with a portfolio of 43M SF. He has executed real estate transactions over $1 billion and has procured and executed the development of 30 Class A industrial assets totaling over 8.5 million square feet.

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