Thank you to our Spring 2017 Sponsors

Is the Oil Bust Really Over?And What Does It Mean for Houston?

Robert W. Gilmer, Ph.D.C.T. Bauer College of Business

May 11, 2017

Perilous Times for the Houston Economy: But Where Are We Now?

• Houston has slowed to no-growth for two years, but has seen no major economic reversal

• Where are we now?• We have probably put behind us the

worst downturn ever for American oil• The U.S. economy continues to grow

at a healthy rate• The East Side petrochemical boom is

over• All forward momentum from the

Fracking Boom is now lost, and it can only be rebuilt slowly

• Where are we going now? Is the recent job growth real? Can it continue? Just tell me the price of oil, please.

For Houston, Our Problems Are Still All About Oil Prices

0

20

40

60

80

100

120WTI $/bbl. Monthly

25

30

35

40

45

50

55

60

WTI $/bbl. Daily in 2016-17

Houston Job Growth Rides Oil’s Boom and Bust

December to December Changes

Jobs Change*2012 118,600 4.3%2013 89,800 3.2%2014 117,800 4.0%2015 20,700 0.7%2016 … through 12,500 0.5%

Texas Workforce Commission

Sector Before RevisionDec to Dec

After RevisionDec to Dec

Jobs Jobs % Growth

2012 118,600 118,800 4.4%

2013 89,800 90,400 3.2%

2014 117,800 118,200 4.1%

2015 15,200 200 0.0%

2016 14,800 18,700 0.6%

Current Slowdown Marked The End Of a Decade-Long Fracking Boom

(annual percent change)

-5-4-3-2-1012345

4.0

0.00.6

2.2

Note: December to December changes, except 2017 which is year-to-date, annualized, and seasonally adjusted. TWC estimates.

Slow But Positive Again : Houston Job Growth Revised Down to 18,500 Jobs In All

of 2015-16(3-month percent change at annual rates, s.a.)

-8

-6

-4

-2

0

2

4

6

U.S.

Houston

Texas Workforce Commission and Bureau of Labor Statistics

Oil-Related Job Losses Grow to 77,200 After Revisions(Net Change in Jobs, Dec. to Dec.)

Sector Dec ‘14 – Dec ’16

New Jobs Percent

Total Payroll 17,300 0.6%

Mining -29,400 -25.7%

Construction 3,200 1.5%

Manufacturing -40,300 -15.5%

Machinery -18,700 -34.2%

Fab Metal -20,500 -28.3%

Wholesale Trade -5,700 -3.4%

Prof/Buss Services -3,000 -0.6%

760.0

780.0

800.0

820.0

840.0

860.0

880.0

900.0

Energy Sectors Begin to Turn in Oct 2016 (000, s.a.)

Added back 10,000 Oil Jobs By March

*Revised Texas Workforce Commission estimates. Oil-Related Jobs = Oil Producers and Services, Machinery and Fabricated Metal, Wholesale Trade, and Professional and Business Services.

Growth Of Selected Services Revised Down But Remains Strong

Number of Jobs in Key Services Revised Down, seas. adj.

1450

1470

1490

1510

1530

1550

1570

Thou

sand

s

New Jobs Added Dec 2014 to Dec 2016 (with recent revisions)

• 22,971 health care (-3,425)• 20,836 food service (-7,850)• 16,805 local government (+3,342)• 10,756 retail trade (-8,679)• 5,954 finance (+3,440)• 4,207 arts/entertainment (-14)• 4,148 private education (+394) • 1,202 accommodation (-492)• 86,026 all 8 sectors (-14,098)

Texas Workforce Commission

Super Bowl

Where Has This Service Sector Growth Come From?

• Where did this services growth come from? • Strong national markets: United Airlines, Sysco, AIG, HP• Petrochemical construction boom in East Houston• Past momentum, built on Houston’s 700,000 new jobs from

2004-2014• In-migration continues strongly for several quarters after job

growth slows• Most direct damage is still confined to oil producers, oil

services, and manufacturing … so far• BUT … we are now 30 months into this slowdown. The

chemical boom is over; momentum has waned; population growth is evaporating. Only the U.S. economy left to help out … and the renewed drilling activity. How strong will it be?

Plenty Of Other Signs Of A Big Slowdown Or Mild Reversal

Houston unemployment rate moves above U.S. to 5.9%

3.04.05.06.07.08.09.0

10.011.0

Houston

Quarterly Sales and Use Tax Collections Down 11.4 and 8.5 Percent for City & METRO MTA

100110120130140150160170180190

Mill

ions

City of Houston

Bureau of Labor Statistics

U.S.METRO MTA

Texas Comptroller, seasonally adjusted; To 2016Q4 by date of economic event

Auto Sales Struggle, While Purchasing Manager’s Index Looks Forward

30

35

40

45

50

55

60

65

70Houston PMI Says Growth

Ahead (Index, s.a.)

U.S.

15000

17000

19000

21000

23000

25000

27000

29000

31000

33000

35000

Auto and Truck Sales Down 29.5% Since 2015Q3

(monthly rate)

Houston

Was It Recession? Ask The Dallas Fed Business Cycle Index

Tracks local business cycle with four variables

180.0

200.0

220.0

240.0

260.0

280.0

300.0

320.0

2000 to 2017

We were on brink of recession in 2016, if not in It

265.0

270.0

275.0

280.0

285.0

290.0

295.0

300.0

305.0

Trough Comes in June 2016

Houston in Five Drilling Downturns:So Far, This One Is a Possible

Mild Recession % Decline Rig Count

% Loss Local Jobs

Dallas Fed BCI

Economic EventQuarters Decline

% Decline

U.S Economic Performance

1980's -82.4 -13.3 20 -17.6 - +

Asian Financial Crisis -46.0 None No Recession + +

2001 Tech/Enron -35.4 -1.3 9 -2.9 -

Great Recession -50.9 -4.1 5 -7.5 - -

Fracking Bust … so far -75.4 -0.5 6 -1.7 +

Note: In the first half of 2016, revisions show Houston lost 16,500 seasonally-adjusted jobs. These jobs were restored by year-end.

What Does Oil Mean for Houston’s Economy?

• It makes us a global engineering and technology center for one of the world’s most important industries

• Makes a major machinery manufacturing center, a major national refining center, and a global producer of petrochemicals and plastics

• It is a major driver of our business cycle• For decades it has provided an edge in economic growth that

has moved us to the fifth largest U.S. metro area• A volatile, commodity-driven industry, it has made the local

economy highly cyclical• Diversification? It does not come free! To get stability you

trade away a faster growth rate

Define the Economic Base as the Jobs that Drive Local Economic Growth

Economic Base Energy Base Upstream Downstream Rest of BaseOil Producers X X X

Oil Services X X X

Manufacturing X

Fab Metal X X

Machinery X X

Refining X X

Chemicals X X

Other Mfg. X

Ex Air Transport X X

Ex Pipelines X X X

Ex Wholesale X X

Ex Prof Services X X

Ex Construction X X X

Houston’s Economic Base Leads an Exciting Life! Non-Basic Follows Later

(3-mo percent change at annual rate)

-25

-20

-15

-10

-5

0

5

10

15

Basic

Non-Basic

About Four Non-basic Jobs In Houston Supported By Each Base Job

3.8

4.0

4.2

4.4

4.6

4.8

5.0

5.2Too many Non-Basic Jobs?Base Shrinks and ServicesJust Keep Growing

How Dependent Is Houston on Oil versus Other Factors?

Total Energy and Non-Energy Base Jobs?

0

100

200

300

400

500

600

700‘000 jobs

Energy Not Energy

Houston’s Energy Share near 50% for Decades

47%

48%

49%

50%

51%

52%

53%

54%

Percent Share Energy

There Are Some Problems Here!

• Nothing definitive can be said about the 1980’s. The industry classifications system changed forever in 1990

• The level of detail from payroll employment (used in our example) is very limited and deficient.

• More detailed data (like County Business Patterns) comes only annually and with a two year lag, and the regional definition changes over time.

• Detailed data is counted very differently than payrolls. There is no accounting consistency between reports in some very important categories

• Out-sourcing crosses up the concept of counting energy base jobs

• Outsource accounting, and workers move from the oil industry to financial services

• What changed? Yes, it is true the energy base got smaller. But the energy multiplier got bigger. There was no diversification.

Let’s Try A Statistical Approach:And Answer Two Questions

• How much of Houston’s employment, measured over the business cycle and measured from one quarter to the next, is driven by the oil industry’s drilling cycle? By the national business cycle?

• Over longer periods of time – which turn out to be 10 to 12 quarters, how do these factors – and others --come into play?

• Population growth, local labor force quality and quantity, infrastructure, regulations, pro-business attitudes, etc. These factors all evolve slowly over time

• We share in broad economic growth trends along with the rest of the U.S. economy. Plus, we get special impetus from the success of the U.S. and global oil industry

The model used is an error correction model from 1990Q1 to 2016Q4 with total payroll employment as the dependent variable, and local upstream employment, U.S. employment, and a trend term as independent variables. Log first differences are stationary; there is no autocorrelation; and no serious inter-correlation among independent variables. There is a significant long-term relationship over about 10 quarters, and no evidence of structural change through the entire period. Percentage estimates shown in the next slide are based on the standardized coefficients from an unrestricted version of the ECM.

How Houston Withstood the Blow from Oil in 2015-16

• What drives quarter-to-quarter job growth?

• Momentum from the prior two quarters: 36.2%

• U.S. economic expansion: 41.5• Local upstream oil-related job

growth: 22.4%

• What drives growth over 10 or more quarters?

• Long-term factors that drive local population growth and productivity: 28.3%

• U.S. economic expansion: 38.6%• Local oil-related job growth:

33.2%

Taking a the Latest Shot from Oil • Over the business cycle, 1/3 oil and 2/3

U.S. cycle. • Over the longer-term, 1/3 is oil-driven,

and the rest by non-oil factors • Houston’s response to oil or U.S.

growth is stable and unchanged over the entire period, indicating little diversification away from oil in the last 26 years

• Remember these figures are on average! There are periods like 2009-2014 when oil booms, but U.S. economy performs poorly. Or the late 1990’s when U.S. booms and oil lags badly.

Oil Markets and Oil Price

The Commodity Super-Cycle Is Over(price index: Jan 2001 = 100)

0

100

200

300

400

500

600

FoodAg Raw MaterialsMetalsCrude Oil

International Monetary Fund

But Global Oil Demand Has Grown SteadilySince 2014: This Has Been a Supply Problem

(million bbl./d)

60

65

70

75

80

85

90

95

100

105

Jan-

97Se

p-97

May

-98

Jan-

99Se

p-99

May

-00

Jan-

01Se

p-01

May

-02

Jan-

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p-03

May

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Jan-

05Se

p-05

May

-06

Jan-

07Se

p-07

May

-08

Jan-

09Se

p-09

May

-10

Jan-

11Se

p-11

May

-12

Jan-

13Se

p-13

May

-14

Jan-

15Se

p-15

May

-16

Jan-

17Se

p-17

Great Recession

Fracking Bust

Asian Financial Crisis/Tech Bust

Commodity Boom

Global Economy Still Trapped in Prolonged Period of Sub-Par Growth

(percent change in GDP)

-6

-4

-2

0

2

4

6

8

10

12

14

16

Brazil China India World

Brazil

China

India

World2.2

1.5

3.6

2.7

1.7

4.4

2.9

1.8

4.7

00.5

11.5

22.5

33.5

44.5

5

World Developed Emerging

Slow Global Growth Led By Developed World

2016 2017 2018

Percent

IMF World Economic Outlook, April 2017

Growth In The Demand For Oil Comes From Emerging Markets

(million b/d)

8.0

18.8

-5

0

5

10

15

20

1996-2003 2003-2016

GlobalOECDNon-OECD

International Energy Agency

On Supply Side? U.S. Shale Reversed40 Years Of Declining Oil Production

(million barrels/day)

4

5

6

7

8

9

10

11

DOE/EIA, Seasonally adjusted by IRF

Peak: July 2015, fell 669,00 bbl/dStill Down 532,000 bbl./d

Thinking About RecoveryIn the Oil Patch

Drilling Has Definitively Turned Up from Historic Lows

300500700900

110013001500170019002100

1 8 15 22 29 36 43 50 57 64 71 78 86 93 100

107

114

121

128

135

Weekly Count of Working Rigs

Weeks after peak in drilling activity

488 Rig Count was previous all-time low

2008-2009

2014-2017

As Oil Prices Rose This Spring, Optimism Returned To The Oil Market

• The big three oil service companies all declared a bottom was in place for drilling in their 2016 earnings reports

• The rig count has more than doubled from the March 2016 low of 404

• Oil service and machinery stocks quickly rose 30% in February and March as the OPEC agreement fell into place. BUT then fell back in March and April with lower oil prices

• But did producers get ahead of themselves? Again trying to drive equity gains instead of profit over the oil-price cycle?

1800

1900

2000

2100

2200

2300

2400

2500

2600

2700

2800

S&P Oil Service And MachineryStock Price Index

Oil prices improve

OPEC accord signed ->

If Oil Producers Are Chasing Equity Gains … It Isn’t Working

5000

5500

6000

6500

7000

7500

8000

S&P Exploration and Production Index

OPEC Agreement

-19.7%

0

10

20

30

40

50

60

70

80

0 5 10 15 20 25 30 35 40 45 50 55 60 65 70 75 80 85 90 95 100

What We Really Need?: Drilling Recovery Means Oil Near $65/bbl.

Long-Run Marginal Cost of Global Oil Production

1

2

3 45 6 7

8

11

910

$/bbl.

Production (million bbl./d)This is chart is stylized and illustrative

Price Of WTI Oil As Implied by Valuation Of The Stock of 40 Oil

Producers

6260

62

56 56

6264

6664

59

55

$50$52$54$56$58$60$62$64$66$68

$/bbl.

Goldman Sachs Research, at first week of each quarter

All OPEC’s Efforts to Drive Higher Oil Prices Seem to Be Lost

$44

$46

$48

$50

$52

$54

$56

$58

$60

WTI Futures $/bbl.

$60/bbl.

May 3Before OPEC Pact

After OPEC Pact

Recovery In Rig Count After Oil Prices Definitively Move Up

(working rigs by quarter after oil prices begin to rise, s.a.)

0

500

1,000

1,500

2,000

2,500

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47

Quarters after recovery

2008-09

1997-98

2001-03

1982-87

Baker Hughes, calculations of IRF

Drilling Costs Fall by Over a Third Since 2014

0.0

100.0

200.0

300.0

400.0

500.0Producer Price Index

No Recent Experience Relating $60-$80 Oil to Oil Rig Count

0

20

40

60

80

100

120

200 700 1200 1700

real oil price

Producers Retreat to Low-Cost Prospects

Oil-directed rigs

Building Scenarios For Recovery In Oil

• When will oil prices hit bottom? • When will the rig count turn up? • When do energy jobs begin to come back?• How high will the rig count go in this

recovery? • How long before the rig count reaches these

highs?

Three Scenarios for a Drilling Recovery

• Rig Count? • High Scenario: Strong recovery like

2008-09 continues to unfold • Medium Scenario: Slows in

2017Q2/Q3 but moderate recovery continues

• Low Scenario falls back in 2017 Q2, remains low and slow trough 2018

• Rig Count Max After Recovery? • High Scenario: 1650• Medium Scenario: 1500• Low Scenario: 1300

• Return of Drilling Jobs in Houston • High Scenario: 2017Q1• Medium Scenario: 2017Q3• Low Scenario: 2018Q4

High scenario requires a quick rebound in oil prices to $55, and continued move to $60-$65 range; moderate requires a return to $55 or better; low scenario triggered by continued oil price near $45, and staying at that level through 2017 and into 2018.

Rig Count Scenarios and the Return Of Oil Employment In Houston

0

500

1000

1500

2000

2500

Jan-

12

Oct

-12

Jul-1

3

Apr-

14

Jan-

15

Oct

-15

Jul-1

6

Apr-

17

Jan-

18

Oct

-18

Jul-1

9

Apr-

20

Jan-

21

Oct

-21

Rig Count

High Medium Low

195

215

235

255

275

295

315

Jan-

07M

ar-0

8M

ay-0

9Ju

l-10

Sep-

11N

ov-1

2Ja

n-14

Mar

-15

May

-16

Jul-1

7Se

p-18

Nov

-19

Jan-

21

Oil-Related Jobs in Houston (000)

High Medium Low

U.S. Economy Continues to Work for Houston

U.S. Economy Continues To Grow Strongly And Create Jobs

• Assume in all scenarios that the U.S. economy has put the Great Recession behind it

• Consumer has deleveraged; state and local governments are collecting revenues at a healthy rate and spending; the housing market has returned to close to normal

• U.S. job growth is at 1.7 percent or about 200,000 jobs per month throughout the forecast horizon

• We see the export sector, especially manufacturing struggling with the strong dollar, but domestic growth is robust

Last Year a Split Emerged Between Growth In Production And JobsGDP Growth Has Slowed

Sharply in Recent Quarters

-2

-1

0

1

2

3

4

5

6

Jan-

12

Jun-

12

Nov

-12

Apr-

13

Sep-

13

Feb-

14

Jul-1

4

Dec-

14

May

-15

Oct

-15

Mar

-16

Aug-

16

Jan-

17

% Change at Annual Rates

While U.S. Job Growth Remains Quite Strong

300.0

400.0

500.0

600.0

700.0

800.0

900.0

Oct

-12

Feb-

13

Jun-

13

Oct

-13

Feb-

14

Jun-

14

Oct

-14

Feb-

15

Jun-

15

Oct

-15

Feb-

16

Jun-

16

Oct

-16

000 New Jobs Per Quarter

Trend holds near 200,000jobs per month

Strong Dollar Hurts Goods-Related Exports

Dollar at Asian Financial Crisis Highs

100

105

110

115

120

125

130

135

140

Dollar Exchange Rate

Dollar Exch Rate

Dollar Strength Hurts Goods Production

110115120125130135140145150155160

Industrial Production in Manufacturing

Ind Prod

Recent Results Are Consistent With Robust Domestic Growth And

Weak ExportsProductivity Growth Is Slow

-4-3-2-10123456

Jan-

00

Apr-

01

Jul-0

2

Oct

-03

Jan-

05

Apr-

06

Jul-0

7

Oct

-08

Jan-

10

Apr-

11

Jul-1

2

Oct

-13

Jan-

15

Apr-

16

% Change in Productivity12 Quarter Average

Weak Export Sector

-5

-3

-1

1

3

5

7

9

11

13

15

Jan-

10

Aug-

10

Mar

-11

Oct

-11

May

-12

Dec-

12

Jul-1

3

Feb-

14

Sep-

14

Apr-

15

Nov

-15

Jun-

16

Jan-

17

% Change Annual Rates

Modest Recovery Continues

Percent Chance of Recession About One Percent Today

0

20

40

60

80

100Financial Crisis

About 1%today

Percent

Consensus Forecast Says Not Too Hot, Not Too Cold

2001 Recession

Source: Chauvet and Piger smoothed recession probabilities, FRED, St. Louis Fed; Philadelphia Fed, Survey of Professional Forecasters, February 2017.

Fed Funds Rate: What the Futures Market SaysMeeting Date Range b.p. Prob. of Increase Change

Current 75-100 --

3-May 75-100 5.3% --

14-Jun 100-125 78.5% +

15-Jul 125-150 5.8% --

20-Sep 125-150 36.2% --

1-Nov 125-150 32.2% --

13-Dec 125-150 54.4% +

31-Jan 125-150 16.6 % --

CME Group, May 7. Table assumes as soon as probability of a rate increase passes 50% an increase is triggered of 25 basis points.

Downstream Petrochemical Boom Is Over for Now

Hockey Stick Surge In Natural Gas Production Brings Collapse in Price

Marketed Production Tcf/month, seas. Adj.

1.25

1.45

1.65

1.85

2.05

2.25

2.45

Natural Gas Prices Collapse($/Mcf)

0

2

4

6

8

10

12

14

16

DOE/EIA

$179 Billion U.S. Construction Boom Is Based On Cheap Energy

• This $179 billion total includes many industries and the TX and LA Gulf Coast are the major beneficiaries.

• Petrochemicals: New ethylene crackers, more ethylene-related expansion in PE, PVC and other derivative plants

• LNG export terminals: To sell surplus natural gas into global markets

• Refiners: Have joined in with additional expansions

Note: The $179 billion figure is based on all U.S. shale-related expansion, estimatedby the American Chemistry Council in March 2017

Natural Gas Energy Content Now Equivalent $16 per Barrel For OilHuge Feedstock Advantages

for Oil Over Natural Gas

0

20

40

60

80

100

120

140

Margins Narrow for Ethylene With Collapse in Oil Price ($/lb)

0

10

20

30

40

50

60

70

DOE/EIA and calculations of the author

Oil $/bbl

Gas $/bbl

Projects Begin To Wind Down Rapidly After 2017

(Value of Projects Completed, $ million)

$8,319

$22,706

$4,980$4,000

$3,000$2,000

$0

$5,000

$10,000

$15,000

$20,000

$25,000

2016 2017 2018 2019 2020 2021

The Gulf Coast Petrochemical Boom Winds Down

Ethylene Finishes UpCompany Where StatusHouston area

ChevronPhillips Baytown mid-2017

Dow Freeport Complete

ExxonMobil Baytown mid-2017

Ineos Chocolate Bayou Complete

Other Gulf CoastFormosa Plastic Point Comfort 2017-2018

OxyChem/MexiChem Ingleside Complete

LyondellBassell Corpus Christi Complete

Ineos/Sasol Lake Charles, La. 2018

Recent AnnouncementsTotal Port Arthur 2020's

Exxon/SABIC Corpus Christi 2020's

Next Wave? ??? 2024-26

Polyethylene Is Right BehindCompany Where StatusHouston area

ChevronPhillips Sweeny 2017Q3

Dow Freeport 2017Q3

ExxonMobil Mont Belvieu 2017Q3

Ineos/Sasol LaPorte 2017Q2

LyondellBassell LaPorte 2019

Other Texas Gulf CoastFormosa Plastic Point Comfort 2018

ExxonMobil Ingleside Complete

Exxon/SABIC Corpus Christi 2020's

Pull It All Together?

• Three oil scenarios: high, medium, or low. High sees solid recovery now underway in drilling; medium sees strength delayed until early 2017; low until late 2018

• Continued U.S. expansion at moderate rates

• A drag from the end of the petrochemical construction on the East Side

• All forward momentum from the fracking boom is gone

• Data revisions that point to possible mild local recession in in early 2016.

Forecast Job Growth In Houston: A Likely Slow Start

(000 New Jobs, Q4/Q4)By Scenario

Year High Medium Low 25/60/15

2014 112.7 112.7 112.7 112.7

2015 11.0 11.0 11.0 11.0

2016 10.8 10.8 10.8 10.8

2017 54.3 35.2 21.2 37.9

2018 79.6 52.6 22.8 54.9

2019 91.4 68.0 42.8 70.1

2020 89.6 74.1 56.8 75.4

2021 91.6 78.8 67.7 80.4Calculations of IRF, based on drilling scenarios above. Figures are Q4/Q4. The 2016 calculations include benchmark revisions of March 2017.

Net Migration Follows Job Growth in Houston

• When population grows, net migration gives the biggest economic stimulus

• As job growth rises, net migration begins to rise a year later

• In recovery, net migration falls a year behind

• Data at right matches 25/60/15 weighted employment forecast, sees a 2018/19 trough with about 30,000 net migrants 0

20

40

60

80

100

120

2014 2015 2016 2017 2018 2019 2020 2021

Annual Increase: New Jobs vs. Net Migration

(Index: 2014 = 100)

New Jobs

Net Migration

Houston Single-Family Housing: A Long, Strange Journey Ends Well

The Fracking Boom Brought Lot Shortages … Then the Oil Bust Did the Same

• The sub-prime Implosion in 2006 left Houston with 50,000 small and scattered lots – and not much other inventory

• By 2012, the Fracking Boom generated strong demand for large homes for high-end engineers/executives

• Existing home supply was quickly exhausted, and there were no lots on the ground to build large homes. Pressure grew on existing homes

• Low inventories and sharply rising home prices slowly squeezed 100,000+ families out of the housing market

• By 2015, the large lot supply caught up – in time for the drilling bust to abruptly end the demand for upscale housing

• The last two years have been spent on lot development for low- to moderately-priced homes with 45-60 foot frontages. The traditional, moderately-priced heart of the Houston housing market is finally back in business

A Strong Existing Home Continues On Despite the Oil Bust

(sales, s.a.)

3500

4500

5500

6500

7500

8500

9500 • Flat since 2012? First, sales flat due to a lack of existing and new home supply. There was nothing left to sell.

• But oil bust drives changes beneath the surface, as existing home market moved downscale in price and home size

• Starter homes and price levels cited above did fine, while expensive and close-in properties faltered

Source: Texas A&M Real Estate Center

Oil Boom and Lot Shortages from 2012-2014 Distorted Single-Family

Housing Market

23456789

Months Supply

140

160

180

200

220

240Median Price ($000)

Source: Texas A&M Real Estate Center, seasonal adjustment by IRF

Ship Channel CitiesBaytown, Channelview, Pasadena

8090100110120130140150160

150

170

190

210

230

250

270

290

Thou

sand

s

Sales and Home Prices Rising

Sales Price

1.5

1.7

1.9

2.1

2.3

2.5

2.7

2.9

Inventory only 2.5 months

InventorySource: Texas A&M Real Estate Center, calculations of IRF

South HoustonSouth Belt, Clear Lake, League City

100120140160180200220240

250

300

350

400

450

500

Thou

sand

s

Sales flat, prices rising

Sales Price

1.4

1.6

1.8

2

2.2

2.4

2.6

Jan-

15M

ar-1

5M

ay-1

5Ju

l-15

Sep-

15N

ov-1

5Ja

n-16

Mar

-16

May

-16

Jul-1

6Se

p-16

Nov

-16

Jan-

17

Not much left to sell withtwo months inventory

InventorySource: Texas A&M Real Estate Center, calculations of IRF

Close-In and UpscaleRice Military, Heights, Galleria

80

130

180

230

280

330

380

430

150

170

190

210

230

250

270

290

Thou

sand

s

Sales and Prices Sag in 2015-16

Sales Price

33.5

44.5

55.5

66.5

7

Inventory falling againas oil prices rise?

Inventory

Source: Texas A&M Real Estate Center, calculations of IRF

South Of I-10 WestMemorial and Energy Corridor

0100200300400500

80100120140160180

Thou

sand

s

Prices hold up, sales recover on better oil price?

Sales Price

1.5

2.5

3.5

4.5

5.5

Inventory falls as sales pick up

Inventory

Source: Texas A&M Real Estate Center, calculations of IRF

The Woodlands Cools Off

250

300

350

400

150170190210230250270

Thou

sand

s

Sales down, Price trying to recover

Sales Price

2.53

3.54

4.55

5.5

Inventories stabilizing near 5.0 months

Inventory

Source: Texas A&M Real Estate Center, calculations of IRF

Other Distant SuburbsPearland, Sugar Land, Kingwood, Katy

200

220

240

260

280

300

300

500

700

900

1100

1300

1500

Thou

sand

s

Sales flat & price increases slow

Sales Price

1.5

2

2.5

3

3.5

Jan-

15M

ar-1

5M

ay-1

5Ju

l-15

Sep-

15N

ov-1

5Ja

n-16

Mar

-16

May

-16

Jul-1

6Se

p-16

Nov

-16

Jan-

17

Inventories remain very low, Not much to sell

Inventory

Source: Texas A&M Real Estate Center, calculations of IRF

Shouldn’t Houston Be Better Than Just Average Affordability?

Largest 10 U.S. Metros and Affordability

• New York 35.4%

• Los Angeles 12.5%

• Chicago 61.1%

• Dallas-Fort Worth• Dallas 50.1%• Fort Worth 64.2%

• Houston 61.8%

• Washington, D.C. 64.1%

• Philadelphia 70.1%

• Miami 33.2%

• Atlanta 69.9%

• Boston 51.2%

40

50

60

70

80

90

Affordability Index: Percentage of Houston homes

for sale within in reach of median income family

Wells Fargo Housing Opportunity Index

Houston’s Homebuilders Rediscover Houston’s Traditional Moderate-

Income Market

New Home Market Shifts To Moderate Priced Homes On Smaller Lots

0355

4296

5441

4661

6029

3206 3258

0

1000

2000

3000

4000

5000

6000

7000

2016 Closings by Price Range $000

5195

7370

2335

3482

17402184 2344

0

1000

2000

3000

4000

5000

6000

7000

8000

< 50 50-54 55-59 60-64 65-69 70-79 >80

2016 Starts By Size of Lots

MetroStudyFrontage in feetPrice in 000

Lot Supply Is Finally Finding an Equilibrium in Houston

26

17 16

2119

23

30

0

5

10

15

20

25

30

35

0

2,000

4,000

6,000

8,000

10,000

12,000

<50 50-54 55-59 60-64 65-69 70-79 >80

Current Lot Inventory Number and Months Supply

3614 3477

1388

2219

1064 1018

473

0

500

1000

1500

2000

2500

3000

3500

4000

< 50 50-54 55-59 60-64 65-69 70-79 >80

Lots Under Development

MetroStudy

Frontage in feetFrontage in Feet

Single-Family Permits Softer in 2016But May Have Room to Grow in 2017

(monthly permits at annual rates, s.a.)

0

1

2

3

4

5

6

Thou

sand

s

Texas A&M Real Estate Center

Apartment Market Keeps on Building

Class A Apartment Market Suffers From Self-inflicted Wounds

Class A Rents and Occupancy Under Growing Pressure

Stable In Lease Up All Class A

No. of Units

114,963 26,886 141,849

Monthly Rent

$1,416 $1,501 $1,432

Occupancy 89.7% 27.4% 77.9%

• Damage is felt first in the rest of Class A, in similar product

• Class A is struggling with rent under pressure from widespread concessions and falling occupancy rates

• There are 27,000 units in lease-up with only 27.4% occupancy, another 15,000 units still in the construction pipeline

Apartment Data Services through February

Class A Apartment Construction Finally Peaks In 2017?

Number of Units

Percent of 2018 Units

2014 existing 120,390 69.2

2015 delivery 18,300 10.5

2016 delivery 17,500 10.1

2017 delivery >17,700 10.2

2018 existing 173,890+ 100.0

-- Metro-wide Class A apartment construction continues at a high pace in 2017-- We thought it peaked last year? Surprise!-- By 2018, the local Class A apartment market will have expanded by 30.8% since 2014, when oil bust began

CoStar

New Product Puts Class A Under Pressure, But Damage Spreading

Class A Rents Under Pressure, but Occupancy Up in Recent Months

7576777879808182838485

1,4001,4201,4401,4601,4801,5001,5201,5401,560

Mo. Rent $ Occupancy

Occupancy (%) now falling in Class B & C

9090.5

9191.5

9292.5

9393.5

9494.5

95

Class B Class C

Apartment Data Services

Entire Market Suffers as Class A Continues to Build

200

250

300

350

400

450

500

550

Class A effective rent premium to rest of market

CoStar says Class A premiumIs down 16.1% Since 2014

• No job growth, and population growth is falling rapidly

• Where are the new Class A tenants? Living in Class B, of course

• Widespread incentives cut the effective rents in Class A to compete with B,C product

Multifamily Permits Finally Slip Under Long-Run Trends

0

500

1,000

1,500

2,000

2,500

Monthly permits, 6-month average

TAMU Real Estate Center

Where Rental Rates Are Under Pressure(12-mo. changes, all classes)

Largest 12-Month Declines• Medical Center -7.8%• Woodlands -6.4%• Upper Kirby -5.9%• Galleria -5.5%• Montrose -4.9%• Lake Hou/KW -3.5%• Jersey V/Cypress -3.5%

Other Notables• Energy Corridor -3.0%• Westchase -3.0%• Heights -2.9%• Downtown -1.2%• Memorial/Spr Br -0.7%• Baytown +0.5• I-10 East +4.7

Note: These are 12-month changes; many of these areas improved substantially in 17Q1 Apartment Data Services

Damage Also Spreads Geographically From Complex To Complex

• Look at all Class A apartment complexes in metro area at end of 2016

• Look at all the other Class A complexes in circle of radius of 2 miles

• Compute the resulting vacancy rate in its market area after new units completed in 2017

• Each dot an A apartment, the darker the spot, the higher the vacancy rate in its market area

CoStar, IRF

Delivered or In Pipeline for 2017

These Multi-Family Vacancy Rates Approach Worst of Modern Times

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

Percent Vacancy All Classes By Forecast

history High Medium Low

Medium Forecast Peaks at 11.4% Vacancy in 2018; Double-digits to 2020 in all forecasts

11.4%

Where Class A Vacancy Rates Are Above 20 Percent By Year End

Ugly As The Office Market Is Today, This Is Not The 1980’s

6.613.9

21.633.6

49.6

70.7

96.5

-0.6

0.1 0.2 2.9 8.320.1 23.2

-20

0

20

40

60

80

100

120

0 1 2 3 4 5 6

Cumulative square footage delivered after 1977 or 2009In Million Sq Ft

1980s 2010s

46.9 million 1982 – 8414.9 million 2014-16

Sure, There Is an Oil Bust, But Vacancy Mostly a Product of Deliveries

-3%

-2%

-1%

0%

1%

2%

3%

4%

0

2

4

6

8

10

12

14

Mill

ions

<-- Annual Deliveries vs Change in Vacancy Rate

Class A Office Market: Feeling a Lot of Pain Right Now?Class A Vacancy Rates Nearly

Double, Head for Modern Highs

8%

10%

12%

14%

16%

18%

20%Vacancy Rates

Class A

B & Below

Class A Rent Premiums Approach 2010 Lows

$0$1$2$3$4$5$6$7$8

Class A Base Rent Premium

Across All Classes of Buildings: Office Vacancy Rate Nears A Peak

8.0%

9.0%

10.0%

11.0%

12.0%

13.0%

14.0%

15.0%

16.0%

17.0%

18.0%

High Medium Low

Medium = 16.4%

13.7%

15.8%

Source: CoStar, IRF Forecast

Average = 13.2%

Damage Spreads Geographically From Building To Building

• Look at all buildings in metro area at end of 2016

• Look at all the other buildings in circle of radius of 2 miles

• Compute the resulting vacancy rate in its market area with new deliveries

• Each dot a building. The darker the spot, the higher the vacancy rate in its market area

CoStar, IRF

Local Office Markets With Vacancy Rate Headed Above 20 Percent in 2017

CoStar, IRF

Industrial and Retail?No Real Excitement Here!

East versus West: Houston’s Economy Split by Energy

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

Industrial East And West Vacancy:East Side Boom Fading?

West Vacancy East Vacancy

West

East

$3.00

$3.50

$4.00

$4.50

$5.00

$5.50

$6.00

$6.50

$7.00

Industrial East And West Rent

West NNN Rent East NNN Rent

West

East

Industrial Construction Slows In East And West Houston

(million square feet)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

1999

2000

2001

2001

2002

2002

2003

2004

2004

2005

2005

2006

2006

2007

2008

2008

2009

2009

2010

2011

2011

2012

2012

2013

2013

2014

2015

2015

2016

Mill

ions

West East

East

West

Retail: Still Waiting for Better Times

• Retail missed the boom of recent years after delivering 16 million square feet in 2006-07, leaving a glut of space that lasted to 2014

• Local growth caught up with retail space needs in 2013-14, and vacancy rates show tightness, and rents are quite healthy

• Retail is still primarily relegated to following the grocery store anchored shopping centers, chasing new home construction around the Grand Parkway

• The current construction pipeline is no threat to the market, growing more slowly than population.

• But be careful – consumer purchases of retail, food service, entertainment and other services have been flat or falling for two years

$12

$13

$13

$14

$14

$15

$15

$16

$16

2.0%

102.0%

202.0%

302.0%

402.0%

502.0%

602.0%

702.0%

802.0%

902.0%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Retail Rent And Vacancy Began to Tighten In 2014

Vacant Percent Direct NNN Rent Overall

Rent $/ft^2

Vacancy Rate (%)

Source: CoStar

Retail Pipeline Is Okay – Despite a No-Growth Retail Market

Growth Rate of Population and Retail Space: In-Line So Far

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

3.00%

3.50%

4.00%

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2017

2018

Population Square Feet

Population

Retail Space

Taxable Sales for Retail, Food and Drink, Entertainment,

Services ($/Q)

5.5

6

6.5

7

7.5

8

8.5

9

Billi

ons

Retail Construction Is Still Mostly Chasing Rooftops In The Far Suburbs

Close-In and West See Single-Family Sales Sag, Inventories Rise, Prices Flat

Monthly Sales Median Price(000) Inventory

2014 Peak Feb 2017 2014 Peak Feb 2017 2014 Peak Feb 2017

Metropolitan Area 7298 7112 200.9 228.4 2.7 3.9

Close-in* 272 216 402.1 382.4 3.8 5.0

Rice Mil/WashAve. 67 45 453.3 423.1 3.2 5.3

Heights 147 120 445.2 430.0 4.3 4.5

Galleria 66 51 312.1 294.1 3.0 5.8

South of I-10* 148 132 384.8 405.9 1.8 4.4

Energy Corridor 80 63 299.4 328.2 1.6 4.3

Memorial West 75 69 471.3 483.7 2.0 4.4

Spring Branch 103 111 320.8 371.8 2.8 5.4

Woodlands 229 167 355.8 326.2 3.1 4.8

Alief 87 83 123.7 147.9 1.8 2.9

(*) denotes the sum of the sub-categories; all data seasonally adjusted and may not add to totals; sales and price are 3-month moving averages

Rest of Metro Single Family: Little Left to Sell, Prices Still Rise

(*) denotes the sum of the sub-categories; all data seasonally adjusted and may not add to totals; sales and price are 3-month moving averages

Monthly Sales Median Price Inventory2014 Peak Feb 2017 2014 Peak Feb 2017 2014 Peak Feb 2017

Metropolitan Area 7298 7112 200.9 228.4 2.7 3.9

Ship Channel* 233 264 124.3 147.4 2.7 2.5

Baytown 85 86 139.5 150.8 2.6 2.3

Pasadena 77 78 118.4 148.6 2.3 1.7

North Channel 78 99 116.5 142.9 3.1 2.9

South Houston* 458 393 192.2 231.7 2.0 2.3

Friendswood 74 62 219.1 246.3 1.6 2.2

Clear Lake 131 125 193.5 229.1 2.0 2.1

League City 190 171 216.6 264.4 2.2 2.4

South Belt 75 59 142.8 178.5 1.3 2.0

Suburbs* 1,311 1,163 253.4 285.7 2.2 2.9

Kingwood 124 95 230.0 240.6 1.5 2.9

Katy 510 425 261.5 264.0 2.5 3.3

Cypress 300 296 245.8 266.9 2.2 2.6

Pearland 214 195 231.8 265.1 1.5 1.8

Sugarland 178 153 390.3 392.0 2.1 3.9

Where Class A Vacancy Rates Are Above 30 Percent By Year End

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

2001

2002

2003

2004

2004

2005

2006

2007

2007

2008

2009

2010

2010

2011

2012

2013

2013

2014

2015

2016

2016

2017

2018

2019

2019

2020

Vacancy Rate For Class A and BClimb From Low Levels

Class A Class B

Class B

Source: CoStar

Class A

Thank you for attending

Our Fall 2017 Symposium is scheduled for Monday, November 6, 2017