Plunging Crude Prices Disrupt Houston’s Property Industry
U.S. oil prices sank into negative territory for the first time on record as fears mount of excess oil during the coronavirus pandemic, making real estate professionals say it could worsen already declining commercial property investment activity.
In the fourth most populous U.S. city, about one-third of the economy is tied to the energy industry. That makes energy companies major investors in real estate across greater Houston.
And it adds to the troubles of a metropolitan area that already had the nation’s highest office vacancy rate, with almost one-fourth of the office inventory empty at the end of the first quarter, according to the Greater Houston Partnership.
So it was a shock for property professionals when West Texas Intermediate crude oil prices for May contracts, which expire Tuesday at the end of the day, closed trading at negative $37 per barrel on Monday. That meant traders would have to pay buyers to take crude off their hands as demand falls with consumers driving less in the pandemic. West Texas Intermediate was trading at about $24 per barrel a week ago and about $62 per barrel in January.
Craig McKenna, a landlord office broker in Houston with Stream Realty Partners, said he thought it was a mistake when he first saw the news about negative oil prices. McKenna summed up the feelings of other local real estate professionals interviewed when he said the drop means more oil-price headwinds for a city that has already been battered for years.
“Outside the virus, there were going to be headwinds to Houston’s economy and that was the case before today,” McKenna said in an interview Monday. “Before today, there were concerns of consolidation, concerns of bankruptcies and concerns of layoffs [in the energy industry] – all of that impacts the commercial real estate market.”
At the same time, McKenna said the energy industry went through significant consolidation in the 2014 and 2015 oil bust so it’s possible the office market may not see the same flood of sublease office space go empty this time. Stream Realty has seen fewer new inquiries, prospects and building tours as deals are shelved or temporarily put on hold. Companies with leases expiring are generally asking for shorter-term renewal agreements for one-to-three years instead of five years, for example.
Eric Anderson, executive vice president with Transwestern in Houston, doesn’t “expect the amount of available space to increase as much as it did in 2015 and 2016” because most energy companies are about as lean as they can be, he said in an email.
Deals, Loans Fizzle
Monday’s historically low crude prices darkened an already dreary mood in Houston. With so much of the local economy tied to the energy industry, oil prices are closely watched by commercial real estate professionals and other industries as a key economic indicator for the city.
Tim Dosch, a land broker with Dosch Marshall Real Estate in Houston, said he’s heard of several multifamily land deals and construction loans that have fizzled out in Houston because of the pandemic and government-mandated lockdown.
Negative or low oil prices make Houston look less attractive for future institutional real estate investment land deals, he said. He added that many institutional investors won’t even consider Houston deals in a very low or negative oil price market.
“The deal could be an incredible deal … but no one wants to go into an investment committee and pitch that deal” involving Houston right now because of low oil prices, Dosch said.
Land deals will probably be financed more through discretionary capital and private equity for the foreseeable future in Houston, he predicted.
“When you’re in Houston, you’re in the oil business,” Dosch added.
Oil Storage Problems
While the International Monetary Fund downgraded its 2020 outlook for the U.S. economy because of the coronavirus and now expects gross domestic product to contract 5.9% this year, it is predicting a rebound in 2021, with GDP growing 4.7% in the United States, more than double the country’s GDP growth in 2019 of 2.3%.
A key reason oil prices are falling is a lack of excess storage capacity. A key U.S. crude storage hub in Cushing, Oklahoma, is nearing capacity as global demand for oil has fallen as much as 35% during the coronavirus pandemic.
“We’re expecting Cushing inventory to [be topped out] at some point in May,” said John Coleman, an analyst at the energy research firm Wood Mackenzie, in an April 20 webinar.
While West Texas Intermediate contracts for May closed in the negative Monday, those contracts for June closed in the positive territory at $20.42 per barrel, down 18% but potentially a sign that prices could bounce back.
The situation is called a “contango” oil market, with traders expecting prices to rise over time and are therefore storing oil to sell when prices are higher.
“The market is not necessarily saying everything is going to be well by June and July, but it is saying there is not a reason to sell off” yet, Coleman said.
The U.S. storage constraints were compounded by the fact that U.S. producers haven’t curtailed enough production yet and an OPEC+ deal to curb global oil production hasn’t taken effect, Wood Mackenzie analyst Ann-Louise Hittle added in a statement.
The OPEC+ deal to cut production by 10% was reached last week but analysts still say U.S. producers will be forced to significantly scale back production. The OPEC+ deal “was a drop in the bucket in terms of rebalancing the market,” said Justin Boyar, CoStar’s market economist for Houston.
Effectively, the production cuts could only amount to about 2.6 million barrels per day reduction, a fraction of the 20 million to 35 million barrels per day loss in demand that is happening because of the pandemic, Boyar said, citing Wall Street Journal analysis of data from the U.S. Department of Energy and Labyrinth Consulting Services.
“It’s this apocalyptic scenario for oil and gas right now,” Boyar said. “The hope is that by Tuesday night when Asian markets open, futures contract prices for June and later will stay in the $20s/$30s and higher or at least teens.”
Updated: April 20, 2020 | 08:22 P.M.
