All Signs Point Up

Houston’s office market has steadily gained strength over the last two years.
This fact is evident in the hard statistics; occupancy, rent, and absorption.
Occupancy has come a long way from when it bottomed out two years ago at
81.99%. Current occupancy stands at 84.24%, which represents a 0.40-point
hike over the quarter, a 1.88-point gain over the year, and a full 2.25-point
increase over rock bottom from two years ago. The Class A market recorded the
highest occupancy at 87.02% over the second quarter. In comparison,
occupancy for Class B, C, & D space ranges from 79% to 82%. Absorption
figures are also very telling. Boosted by this quarter’s absorption of 890,680
square feet, absorption over the last year is at 3,117,897 square feet. This is the
strongest annual absorption figure in five years.

Average rental rates have once again climbed back up to levels not seen in a
couple of years. Current rents are at $18.44 per square foot (psf), representing a
$0.04 psf gain over the quarter and a $0.38 psf, or 2.1%, gain over the year.
Class B rents, which are at $17.17 psf, have risen the fastest. Over the last year
Class B rents have gained $0.46 psf (2.75%) compared to Class A which gained
$0.30 psf (1.44%), while Class C and D rents have remained relatively flat.
Not only is it evident the market is gaining strength through hard statistics, it is
also showing up in sales activity. Since the beginning of this year, Houston has
already registered 29 sales of multitenant office properties. Thirteen of the
buildings that traded hands are classified as A, with another 11 of the sales being
Class B properties. These properties were likely targets as they are currently
outperforming market averages, with average occupancy at 90% and average
rents at $20.46 psf.

Some of the more notable deals that have occurred this year include Brookfield
Properties Corp. in partnership with Blackstone Group’s buyout of Trizec
Properties, who owned seven high-profile properties in Houston’s Central
Business District, including Continental Centers I & II; One, Two, and Three
Allen Center; 500 Jefferson Building; and the Kellog, Brown, & Root Tower.
Also of significance was Thomas Properties Group, Inc.’s purchase of four
BMC Software buildings in the Westchase area. Recent sales information is a
clear indicator that investors are once again interested in the high quality
products Houston has to offer at a relatively affordable price compared to coastal
markets. And when combined with the increasing health of the market, it is likely
that investors’ interest will only continue to rise.

Metro Occupancy Overview

Overall occupancy picked up 0.40 points over the quarter to 84.24%. Occupancy is an impressive 1.88 points higher than it was at this time 12 months ago, and is at its highest level in two years. Classes A and C made the largest strides over the quarter,
gaining 0.51 and 0.59 points, respectively, with Class B posting modest quarterly gains.
Class A reported a 0.51-point increase in occupancy over the quarter and a 2.75-point
increase over the year to 87.02%, which is the highest it has been since the second quarter of 2003. Occupancies in the three largest sectors, Galleria, Central Business District, and Westchase, stand at 86.93%, 84.38%, and 89.88%, respectively.
Class B posted a quarterly gain of 0.26 points and an annual gain of 1.25 points to bring occupancy up to 82.29%. The Northwest sector posted the lowest occupancy at 67.00%, while the Northeast 1 sector led the market with occupancy at 96.56%.
Class C occupancy recorded the largest increase of all categories over the last quarter with a gain of 0.59 points to 81.89%. Over the year, occupancy is up 0.89 points. Southwest 2 and The Woodlands/Conroe posted the area.s strongest occupancy levels at 95.62% and 94.29%, respectively. Greenspoint/Northbelt posted the weakest occupancy level just under 75%.
Class D was the only class to register a quarterly drop in occupancy and continues to post the lowest occupancy of all classes. Occupancy in the Class D market declined 0.11 points over the quarter to 79.29%. In spite of the loss, average occupancy remains 1.24 points above last year.s level.

Metro Rent Overview

Overall rental rates recorded their fourth consecutive quarterly gain, increasing $0.04 psf over the 2^nd Quarter of 2006 to $18.44 psf. The increase was fueled by the Class B market, which was the only class to post a quarterly gain in rents. Rents in both
Class A and D declined over the quarter, while rents in the Class C market remained flat.
Class A rents dropped $0.23 psf over the quarter. However, at $21.15 psf, rents remain $0.30 psf higher than last year.s level. Rents were highest in The Woodlands/Conroe and Katy Freeway West sectors at $22.59 psf and 22.27 psf, and lowest in
Kingwood at $12.00 psf.
Class B posted the largest quarterly increase in rents, up $0.23 to $17.17 psf. Class B also posted the largest 12-month gain in average rental rates, increasing $0.46 psf. Major contributors to the strong rental rates are the Medical Center and Midtown/Allen Parkway where rents average $22.04 and $18.59 psf, respectively.
Class C rents held steady over the last quarter at $13.77 psf, and are up $0.12 psf over the last year. Rents ranged from $12.00 psf in the Southwest 1 & 2 and Northeast 2 sectors to $16.25 psf in Greenway Plaza.
Class D rents, at $11.27 psf, registered a $0.15 psf quarterly decline, and a $0.23 psf annual decline. Class D was the only
class to post both a quarterly and annual decline in rents. The highest Class D rents were found in Katy Freeway East at $13.58 psf, while the lowest rents were found in the Southeast at $9.86 psf.

Metro Absorption Overview

Fueled by positive figures in the Class A, B, & C markets, overall quarterly absorption reached 890,680 SF. The Galleria enjoyed the largest quarterly gain, with 357,390 SF absorbed. Overall annual absorption is beyond 3 million SF, a milestone of health in this market where annual absorption just two years ago registered -2.4 million SF.
Class A had another strong showing, absorbing 446,892 SF over the quarter, the most of all classes. Absorption over the year is now totals over 2.3 million SF. Demand for office space was greatest in the Galleria and Sugar Land/First Colony, where quarterly absorption was 259,555 SF and 119,902 SF, respectively.
The Class B market rebounded this quarter, absorbing 180,732 SF. Annual absorption stands at 314,900 SF. The positive turn over the last quarter was largely driven by the Westchase sector, which posted absorption of 89,310 SF. The Clear Lake sector recorded the greatest loss this quarter with absorption of -19,189 SF.
The Class C market posted yet another quarter of positive absorption, with 269,726 SF absorbed. Positive absorption over the last three quarters has boosted 12-month absorption up to 378,684 SF. The Southeast market outperformed all other sectors with 160,401 SF absorbed, while the North Loop/Northwest Freeway trailed the market with -27,851 SF absorbed.
Class D absorbed -6,670 SF over the quarter. Despite the loss, annual absorption remains in the black with 72,129 SF absorbed. The Clear Lake sector posted the largest loss with -5,927 SF absorbed, followed by Foutainview/Gessner with negative absorption of 5,465 SF.

Traditional, Multitenant Office Inventory by Class

There are a total of 1,282 operating traditional, multitenant office properties in the Houston area market with total net rentable square feet of 157,458,306. Approximately 44.79% of the total office space is Class A, 36.81% of the total office space is Class B, 14.82% of the total office space is Class C, and 3.58% of the total
office space is Class D.

Job Growth

The civilian labor force unemployment rate in the tencounty Houston MSA increased to 5.6%, while the total number of nonagricultural wage and salary jobs increased to 2,411,800 in June 2006, according to the Texas Workforce Commission. This month.s total is 59,400 jobs more than at this time last year. Of the nonagricultural employers, Professional & Business Services gained 20,300 jobs over the previous 12 months; Natural Resources, Mining, & Construction gained 10,100 jobs; Education & Health Services is up 8,000 jobs; Trade, Transportation, & Utilities added 7,700 jobs; manufacturing added 4,800 jobs; Financial Activities gained 4,300 jobs; Other Services gained 2,700 jobs; Government employment increased by 2,000 jobs; and Leisure & Hospitality added 600 jobs. The only industry to lose jobs over the year was the
Information sector with -1,100 jobs.

http://www.poconnor.com/file_repository/Houston-Office-Performance-2Q2006.pdf

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