David Toti Comments: As Consumers Cheer, Plunge in Oil Prices Poses Test for Texas Real Estate

December 18, 2014, CoStar News

CoStar Portfolio Strategy analyzed the effect on local GDP of a further 20% drop in oil, with Houston leading the list with a reduction of more than 2%, followed by other energy centers like Oklahoma City and New Orleans. Sunbelt markets like Atlanta, Phoenix, Tampa and Orlando would enjoy the most upside, growing up to 2%, with the increase adding about 0.5% growth to national GDP.

Office vacancies declined in Houston when the price of crude oil increased in 2004. A precipitous drop in crude prices at the beginning of the Great Recession was followed by a rise in vacancies, which then compressed again as oil recovered. The Houston vacancy rate has started to move slightly higher following the more than 25% decline in the price of crude oil since June.

However, the potential hit to Houston may be overstated. Given the recent local growth and U.S. economic strength, growth in the nation’s energy capital will likely only slow to 3%-4% from the 5%-7% growth of the past several years, CoStar Portfolio Strategy said.

"In other words, Houston will look more and more like a typical U.S. growth market – but with a massive supply wave on the way and discordantly high pricing," Affleck said.

Falling share prices of Cousins Properties Inc. (NYSE: CUZ) and Parkway Properties Inc. (NYSE: PKY), publicly traded REITs which have significant exposure to Texas and Houston in particular, are an early indicator of the volatility of energy prices in the Lone Star State. Both stocks traded down recently on concerns over lower oil prices, falling to their lowest levels since March and prompting downgrades of Cousins Properties shares by Bank of America and Stifel due to concerns about the impact of falling oil prices on Houston’s office market.

Cousins’ office portfolio includes six properties located in Texas totaling 8.1 million square feet, representing 60% of CUZ’s total net operating income, with 48% in the Houston metro area alone. The company’s top 20 tenants represent 42% of the entire portfolio, including four giant publicly traded oil and gas firms, and 20% of the Cousins leased office portfolio is expected to expire in the next three years.

Parkway Properties also has a strong presence in Houston, with 10 properties totaling 4.3 million square feet making up 34% of the company’s wholly owned portfolio. The company also has exposure to the Austin market through a joint venture portfolio of 2.4 million square feet.

Both companies have been in growth mode during the Texas real estate boom, acquiring and building assets across the Sunbelt and Texas. Underwriting of those richly priced deals assumed robust leasing growth against a backdrop of strong energy industry job growth, said David Toti, senior REIT analyst for Cantor Fitzgerald.

Crude oil prices and vacancy rates in the Houston, Austin, and to a lesser extent Dallas office markets are have been highly sensitive to crude oil prices over the past decade, Toti said.

"Although we do not see a significant risk here, we believe if the slump continues and the energy sector displays further signs of weakening, the re-leasing dynamic in the Texas office markets could be challenged," he said, noting that 37% of Parkway’s office space is scheduled to expire in the next three years –including Halliburton Energy Services, Inc., the largest energy tenant and Parkway’s second biggest overall with 2.9% of annualized rent, set to roll in early 2015.

"We believe significant stress in the energy industry could potentially revive investor fears and increase risk aversion relative to the Texas/Sunbelt-exposed REITs," Toti said.

The economic impact on office, apartment and industrial real estate is largely a Texas story for now.

In an analysis of CMBS loans secured by office and industrial properties exposed to oil and energy, Morgan Stanley identified 59 properties encumbered by 50 loans across 37 deals with a total allocated loan balance of $2.2 billion. Over 60% is located in Texas with 45% in Houston, and another 20% in Denver. No other city has more than 7.5% exposure and no other state has more than 5% exposure, according to Morgan Stanley CMBS analyst Richard Hill.

The largest loan exposure is the $168 million securitized loan encumbered by Brookfield Office Properties’ Two Allen Center in Houston. Chevon subleases more than 300,000 square feet from Devon Energy until January 2020 and Eni S.p.A, a major integrated energy company, leases 141,171 square feet of the property until January 2020.