Oil Prices and Commercial Real Estate

Summer 2015

Will lower oil prices have a positive impact on CRE?

U.S. OIL PRODUCTION is expected to grow to 9.23 million barrels per day in 2015, according to the U.S. Energy Information Administration.In 2016, it will grow to 9.31 million barrels daily, as the domestic economy expands and drives up demand. 

Despite recently announced cutbacks in budgets by a number of oil-service companies, many continue to operate oil wells already started and plan to shift their resources to highly productive wells and areas in the months ahead. Additionally, while downstream industries such as petrochemicals and refining benefit from lower oil prices, growth in this segment of the energy market might not be enough to mitigate total layoffs, as job growth will moderate this year.

Strong hiring in sectors such as construction, where single-family and multifamily housing development are creating new positions, will offset losses in the energy sector, even in Texas markets such as Houston, which will bear the brunt of energy-related job losses nationally. Even in Houston, however, more than 50,000 new jobs will be brought online in 2015.

Oil prices are just high enough to support limited development drill­ing this year in the Bakken, Eagle Ford and Niobrara formations and in the Permian Basin. Companies that have lower drilling expenses and debt costs, and that hold acreage in the most productive areas of these regions, will remain active during the year. The shift in the focus of producers to the most economical locations during the year, however, will result in the decommissioning of several hundred rotary rigs and the idling of many field crews. According to Baker Hughes, as of early 2015, oil producers have taken nearly 400 rotary rigs out of service in Texas, the country’s top oil-drilling state. This trend will reduce some of the pressure on the sector, easing the risk of rising supplier cost.

head shot of Alan Pontius

Alan Pontius

Although growth of energy jobs will be put on hold this year, a rapid decline in oil prices will have a net positive impact on commercial real estate overall, particularly in the retail and industrial sectors. Reduced gas prices will boost U.S. discretionary income by about $150 billion in 2015, according to economists at Goldman Sachs, putting money that would have gone to filling gas tanks into consumers’ hands.

The broader lift to the economy resulting from lower manufacturing and logistics costs, increased consumption and the associated ripple effect will add an estimated $400 billion to the U.S. economy. Many of the benefits will be weighted toward the industrial and retail sectors, as retail demand is boosted by consumers with increased discretionary spending for goods related to oil savings. Operators of industrial buildings will benefit as online retail demand increases the flow of consumer goods through their facilities.

In a recent Marcus & Millichap commercial real estate investor survey, 53 percent of industrial investors indicated that they expect vacancies to tighten this year. In addition, overall, commercial real estate investor sentiment is at its highest level since the survey’s commencement in 2004.

As noted above, the direct impact of lower energy costs primarily affects retail and, by extension, industrial real estate, because of the increased consumer spending triggered by savings on gas prices at the pump. The implications of lower energy costs will be less apparent for office properties. However, overall economic gains will continue to support the recovery in office fundamentals.

Across the board, fundamentals are improving and there is increasing confidence in the market that occupancy gains are soon going to generate strong rent growth in the office, retail and industrial sectors. Although the construction pipeline has increased, relatively little new space is being introduced on a national basis. Houston is the exception, with completions forecast to be the equivalent of 4.2 percent of total inventory at the beginning of 2015. Houston aside, there is virtually nothing on the supply side that could derail the recovery, and that is lifting investor confidence in the sector.