After a year of despair in 2020 with major commercial markets dead across the US, 2021’s Houston market is looking more like a new version of George Lucas’s 1977 motion picture Star Wars, “A New Hope”. It’s hard to believe that we’re in a better position economically than last year knowing we’re faced with inflation affecting the commodities sector and overall development costs related to supply & demand, the Federal Reserve continuing to lower interest rates and the current administration planning to increase capital gains taxes. With that being said, I see all of the above as contributing factors to this bullish drive in Houston’s Commercial Real Estate Market.
Out of the main asset classes within commercial real estate, the demand for industrial warehouse space and investment sales surpasses all other assets without a doubt this year. As mentioned, the key drivers are causing a 30% - 50% increase to the per square foot value for industrial warehouse space. This demand is causing a major shortage in supply, which is why we’re beginning to see more and more Industrial properties trading above $150 - $180 per square foot in the improved space outside the Houston metro area. Not only that, but Houston’s industrial vacancy rate decreased 10 basis points from Q1 to Q3, down to 9.0%. This goes to show that our market is in dire need of updated/functional industrial space.
Clearly the high demand has its pros & cons which causes confusion to some and provides profitable opportunities to others, such as out-of-state investors currently flooding our market with 1031 exchanges. It’s obvious that the majority of the investors from California and New York are coming to the Houston market to reposition their assets in order to avoid unnecessary expenses like state income taxes, especially before the looming increase to the capital gains tax. The massive wave of savvy out-of-state investors repositioning their assets in the Houston market has caused a shift in overall cap rates among varying asset classes. For example, industrial investments from 2017 to Q1 2021 were trading between 8.5% - 11% cap rates. Now we’re seeing trades coming in around 6.5% - 8% for industrial single or multi-tenant Investments. This goes to show that the overall price per square foot has affected the rate of return for industrial investment sales in our market.
With whispers throughout the rumor mill of the current administration preparing to increase capital gains taxes, along with the Fed’s intent to keep interest rates low, owner-users, investors & private equity groups are vigorously seeking out new assets to “park” their capital in for the foreseeable future. The recent threat of dissolving 1031 exchanges is just another motivating factor; the effects of which will not be truly seen until it’s too late. However, for now we will continue to see Houston’s industrial investment market remain profitable into the future.