Downtown Houston boasts the new $100 million Hobby Center for the Performing Arts and swanky new clubs, but the city's revitalized entertainment district can't divert the business community from the hole where the energy trading business — and thousands of related jobs — used to be.

Enron Corp., the energy-trading titan that once ranked No. 7 among Fortune 500 companies, filed for bankruptcy last December in the wake of an accounting scandal. Then Dynegy Inc., another major energy trader based in Houston, lost billions of dollars in stock market value. Dynegy, like fallen rival Enron, has been selling assets and cutting jobs as it scrambles to raise cash.

The financial woes of these energy giants have left their mark on the Houston office market — Dynegy put roughly 100,000 sq. ft. of downtown office space back on the market in August. And Enron South, a 40-story, 1.2 million sq. ft. tower originally designed as the shiny, new headquarters for Enron, sits empty except for four of its floors. The property, formerly owned by Enron, was put up for bid in U.S. bankruptcy court, which approved a $102 million bid from New York-based Intell Management and Investment Co. on Oct. 10. Intell paid roughly $85 per sq. ft., which is less than half of what Enron spent.

Corporate downsizings have contributed to a spike in vacancy rates in the CBD, from 4.5% in the second quarter of 2001 to 7% in the second quarter of this year, according to the Houston office of Dallas-based The Staubach Co. Still, that would make downtown Houston one of the healthiest downtown office submarkets in the country. But industry observers such as The Staubach Co. fear the problems at Dynegy and Enron, along with the uncertain growth prospects for a handful of major Houston companies that call downtown home, could push the vacancy rate to nearly 20% — where rival Dallas now stands (see page 44).

“In 2003 and 2004, the tenants are going to have an advantage in negotiations,” says Dan Bellow, president of the Houston office The Staubach Co., pointing to the rising vacancy rate downtown.

The current state of the Houston office market is in stark contrast to a 12-month stretch from April 2000 to April 2001, when the market absorbed 4.4 million sq. ft. Absorption dropped to negative 427,917 sq. ft. from April 2001 to April 2002, a swing of nearly 5 million sq. ft., according to Houston-based O'Connor & Associates.

The city's overall office vacancy rate in the second quarter registered 13.2%, up from 11.8% a year earlier. The Class-A vacancy rate — 9.3% — was stronger, but still higher than the 8% rate of a year ago. One of the markets pushing up the city's vacancy rate is the Galleria market west of downtown, which registered a Class-A vacancy rate of 14.4% in the second quarter, according to O'Connor & Associates.

Hotel Development Accelerates

Hotel development is exploding downtown, and analysts say that's a good thing. “Houston has been under-hoteled since the late 1980s,” says John Keeling, a hotel industry analyst in the Houston office of PKF Consulting, San Francisco. As a hotel city, Houston has been third-tier, but should bump up to second tier with the more than 2,300 rooms that are being added in downtown alone, says Keeling.

The 2,300 rooms will essentially double downtown Houston's hotel capacity. But even with the substantial additions, the number of hotel rooms in Houston's CBD will only roughly equal the number of hotel rooms in Austin, which is roughly one-quarter the size of Houston.

There are several major hotels in various stages of development. Topping the list is the city's soon-to-be largest hotel, the 1,200-room Hilton Americas. Slated to open in late 2003, the Hilton will be owned by the City of Houston. Skywalks will connect the Hilton Americas to the George R. Brown Convention Center, which will be renovated by then.

HOUSTON VACANCIES
2nd quarter 2001 2nd quarter 2002
Office (CBD)
Source: The Staubach Co.
4.5% 7.0%
Industrial
Source: Cushman & Wakefield
8.2% 9.9%
Multifamily
Source: O'Connor & Associates
6.8% 7.1%
Retail
Source: O'Connor & Associates
12.8% 14.2%
Unless otherwise noted, statistics provided are for the metro area.


Just a few blocks away from the Hilton Americas will sit the Inn at the Ballpark, which broke ground in August. The 202-room Inn at the Ballpark, scheduled to open in October 2003, is under construction at Texas Avenue and Crawford, a street just beyond the outfield of Minute Maid Park, the new home field for the Houston Astros. The $38 million hotel marks one of the latest real estate plays by Houston-based Landry's Restaurants, which operates nearly 250 outlets nationally.

The Inn at the Ballpark is the latest example of development spurred by Minute Maid Park, originally named Enron Field. The ball field has spurred the development of restaurants and loft apartments.

Minute Maid Park marked the beginning of a construction boom for sports venues in the city. Reliant Stadium, a $400 million football palace for the NFL's Houston Texans, opened this year, and a $202 million arena for the NBA's Houston Rockets is slated to open next September. The hotel industry stands to benefit from the new stadiums. Reliant Stadium will host the Super Bowl in January 2004, and Minute Maid Park will showcase Major League Baseball's All-Star Game in July 2004.

Average downtown hotel rates, which jumped from about $119 per room in 1997 to approximately $159 this year, will be flat through 2003, Keeling predicts. In the metro area, average daily room rates (ADR) held steady at $77.64 in the second quarter compared with $77.46 in the same quarter last year. “We won't start to see real rate growth again until 2004,” says Keeling. The occupancy rate in Houston fell from 68.1% at mid-year 2001 to 63.5% at the same time this year, according to PKF Consulting.

Mixed Retail Bag

Retail is a weak spot in the Houston commercial real estate market. Houston's retail absorption was a healthy 1.5 million sq. ft. from May 2000 to May 2001, but it posted a negative 345,748 sq. ft. from May 2001 to May of this year, according to O'Connor & Associates. The negative trend is due in part to the decision by Boise, Idaho-based Albertson's Inc. to pull its 43 grocery stores out of Houston. Rival Kroger Co., the region's dominant chain, purchased 16 of the stores.

Houston's retail vacancy rate increased from 12.8% in second-quarter 2001 to 14.2% in the second quarter of this year, marking the first time in five years that vacancy has exceeded 14%, according to O'Connor & Associates. The city's absorption picture would have been worse if not for strength in regional malls. O'Connor & Associates points out that regional malls led Houston retailers with more than 46,000 sq. ft. absorbed in the second quarter.

The city's East End is enjoying a resurgence in retail development, thanks to Houston-based Wulfe & Co.'s $90 million redevelopment of Gulfgate Center, which is the city's first regional mall. In another major project, Houston developer MetroNational recently wrapped up a $110 million redevelopment and expansion of Memorial City Mall on the city's west side. The mall includes a new 300,000 sq. ft. Foley's flagship store owned by St. Louis-based May Department Stores Co.

Multifamily Moves Ahead

Although the apartment occupancy rate for metro Houston was lower than the national rate of 94.7%, the market is bucking the national trend of declining occupancies. The mid-year national occupancy rate marked a 1.4 percentage point drop over second-quarter 2001, but the apartment occupancy rate in metropolitan Houston stood at 93.2%, up a bit from 92.9% a year earlier, according to O'Connor & Associates.

Fort Bend County, a sprawling suburban market southwest of downtown Houston, boasted an occupancy rate of 95.8% at mid-year, up 5.6 percentage points from the previous year, according to O'Connor & Associates.

High-end condos continue to sell in the Galleria shopping district's Uptown Park area. Houston-based Interfin Holdings is building Montebello, a 112-unit, $100 million condo complex in Uptown Park. Typical unit prices range from $500,000 to $1.5 million or more.

In Uptown Park's tony retail district, Houston-based Hanover Co. is developing a 356-unit rental project known as the Lofts on Post Oak, which is scheduled to open in early 2004. “The hot market is multifamily,” says Stan Creech of locally based Stan Creech Properties. “Right now, the strength is coming from the suburbs.”

Jim Greer is a Houston-based writer.