AXIS IN THE NEWS

TENANT CONFIDENCE IS HIGH BUT SO ARE OCCUPANCY COSTS

A positive economic environment, along with strong job growth, has resulted in an extremely healthy Houston office market. Tenants are confident about the future but are faced not only with increasing occupancy costs but also the dilemma of paying for a portion of their tenant improvements.

2006 was a terrific year for the Houston office market. The absorption over the past twelve months has driven the vacancy rate below 10% in Houston's Premier Office Submarkets.

On the new construction front, approximately 4 million square feet is currently under construction, the highest total in nearly eight years. Five development groups currently have plans to build new downtown office buildings. Only one at this point, Discovery Tower, will be built on a speculative basis.

It seems as though the light switch for the downtown office market turned on in 2006 – almost as fast as it was turned off in 2002. Of course, we've seen these shifts before, going back to 1979 when the office market was red hot and the construction of many of the buildings that define our downtown skyline were underway. Then the Energy Bust turned the light switch off for almost two decades.

By 1999 rental rates in the central business district were approaching the $30 range and buildings such as Calpine (now known as 717 Texas), Five Houston Center, Reliant Energy Plaza and 1500 Louisiana (known as the second Enron building) were set to be completed in 2002 and 2003. As a result of a national economic slowdown and the ripple effect from the Enron collapse, the office market again came to a screeching halt.

As we approach 2008 and the end of another decade, tenants have limited options, especially if they're looking for 100,000+ square feet of Class "A" space Downtown. Smaller tenants have more options but face increasing rental rates as well.

While office rents are rising, so are operating expenses and interior finish construction costs. Tenants, while moving or expanding, are not only facing increased occupancy costs in the form of higher rents, but also the reality of additional out-of-pocket expenses to construct a space to fit their needs.

Currently, occupancy costs are just a small percentage of the majority of the large downtown users' monthly expenses. Tenants are confident about the future, so many are accepting construction costs as a cost of doing business. But, tenants should understand the market fundamentals in order to secure the best leasing option and structure their leases to prepare for any future slowdown. The forecasted Net Rental Rate plus expenses for new office towers of $45 - $50 psf, combined with Tenants paying for a portion of their improvements, will get the attention of any large corporation.

The forecast for Houston's economy through 2010 looks strong. What drives the office market is job growth, specifically office job growth. According to Barton Smith, the Houston market added 20,000 new office jobs last year and the forecast for continued office job growth is good through 2010.

Over the past four decades, new Downtown Houston office tower construction has been a leading indicator that the office market will be significantly weaker at the end of the two – three year time period it takes to construct new 600,000 – 1,000,000 square foot office buildings. Will we break this pattern as we enter a new decade?

Scot Ison is President of AXIS Tenant Advisors. Scot can be reached at sison@AXISproperty.com.