Houston Office Market Report | Q3 2024

Rising construction costs are creating more of an impact on leasing expenses for tenants looking to design and build attractive and functional office spaces.

A recent Construction Pricing Index based on metrics from the Bureau of Labor Statistics provided monthly and year-over-year trends on construction material pricing. Compiled by Houston-based construction firm O’Donnell/Snider Construction, the index also compared material pricing between today and pre-COVID levels. One key takeaway: although construction material prices have dropped from their peak (which was 60% higher in May 2022), they are still about 43% higher than in January 2020.

Consequently, Tenant Improvement Allowances (TIs or TIAs) – the money landlords provide to tenants for office-space buildout — are becoming a focal point during lease negotiations. Business owners continue to prioritize enhancing the office environment to attract employees back to the workplace.

The common practice for tenants to cover the difference between the landlord-provided TIAs and their desired scope could be changing due to rising costs and economic uncertainties. Some tenants are becoming reluctant in deploying capital towards buildout, eventually looking to landlords to shoulder the difference.

Historically, landlords have offered sizeable TI packages to remain competitive in attracting and retaining tenants, creating an expectation that landlords will provide a significant portion, if not all, buildout expenses. Yet, persistent inflationary pricing has banks and financial institutions tightening their lending criteria amid economic uncertainty, leading to reduced liquidity and fewer options for landlords seeking to fund buildouts. This situation is compounded by elevated interest rates, making borrowing even more expensive.

In summary, the 43% increase in construction materials costs, compared to pre-pandemic levels, is creating a challenging landscape for landlords, who are facing financial constraints while still needing to fund tenant demands to remain competitive and sustain their portfolios.

Despite these ongoing economic challenges, both tenants and landlords need to explore collaborative solutions to bridge the gap. Strategies such as maximizing the overall lease terms or agreeing to more standardized buildout designs can create both mutual benefits and shared costs.

Ultimately, the key lies in prioritizing an open dialogue so both landlords and tenants can successfully navigate the complexities of the current market and find innovative ways to create more attractive and viable office spaces.