A Tale of Two Cities

It is roughly 1,600 miles from both Los Angeles and New York, but Houston sits squarely in the middle of the country and at the epicenter of a soaring economy. With an unemployment rate of 3.7% (lowest in the nation), an economy that is diversifying beyond the traditional oil sector (energy is 26% GRP versus 52% eight years ago), and a business-friendly climate where 26 Fortune 500 companies make their home, Houston is enjoying a boom that is the envy of both coasts.

Without question, Houston owes some of its success to the energy sector but the industry has diversified beyond traditional “big oil”. Allied high tech industries have grown up to support this global industry including software research and development for refining, alternative energy (Houston leads the nation in windmill technology), and advanced engineering. Makers of energy-related products — pipeline parts, high-pressure drill bits and seismic instruments — are experiencing an upturn in business that has led to an increase in manufacturing jobs in Houston.

Surprisingly, the largest employer is not big oil but the Texas Medical Center, which runs 14 hospitals and two medical schools. Employment in the Houston area has grown 2.8% in the past year, the highest rate among the nation’s 39 largest metropolitan areas. It is predicted that one million people will relocate to Houston through the end of the decade.

Houston also is benefiting from growth in the import and export of goods. Today the Port of Houston is the busiest port in the nation and is on track for more significant growth. In 2007, exports rose 25% to $72 billion. Houston shipped 215 million tons of cargo and it is now the number one port for shipping foreign tonnage. A sophisticated logistics and transportation infrastructure has developed to support the Port’s growth, which has bolstered employment.

Because of the strength of its economy, the nation’s fifth largest office market is holding up well with Commercial Real Estate enjoying solid growth. For the first three months of 2008, Houston had net absorption of 0.68 million square feet. During that same period, occupancy stayed solid with the Houston CBD boasting 91.1% occupancy, while the suburban submarkets maintained 87.4% occupancy.

By comparison, Los Angeles is struggling under the weight of the sub-prime mortgage crisis and the fallout in the financial services sector, which edged unemployment up to 6.8% in June. The Los Angeles County office market is facing increased softness in vacancies, which increased 40 basis points to 10.1%. With nearly 627,000 sf of negative absorption for the same period, this is the first time in six years that the market has posted back to back quarters of negative absorption with no rent growth. So why does an office building in LA trade at a 15% lower CAP rate?

Clearly, both markets will benefit from their diversified economies and the fundamental strength of the U.S. economy when it happens, but higher energy costs and a weak dollar will continue to play to the strengths of a growing regional powerhouse like Houston.