Office Market Continues Recovery; Conditions Expected to Favor Landlords
The office leasing market ventured deeper into its recovery cycle, with vacancy rates declining for the eighth consecutive quarter and net absorption of space outpacing supply, according to a property management firm’s analysis.
The office leasing market ventured deeper into its recovery cycle, with vacancy rates declining for the eighth consecutive quarter and net absorption of space outpacing supply, according to a property management firm’s analysis.
Vacancy rates ended the first quarter at 14.3 percent compared to 14.6 percent in the prior quarter and 16.4 percent in the year-ago quarter, according to an analyses by Grubb & Ellis. However, vacancy remains above the generally accepted equilibrium vacancy rate of 10 to 12 percent, a sign that tenants continue to call the shots in quite a few markets.
In addition, the analysis found market conditions remain tight in the nation's central business districts, which ended the quarter with an average vacancy rate of 13.1 percent compared to 14.9 percent in the suburbs. Although suburban markets had been recovering more quickly, this trend was reversed in the first quarter as the central business district vacancy rate fell more sharply.
Specifically, the analysis found:
- Among the major markets, the Inland Empire (Riverside-San Bernardino-Ontario) area of Southern California posted the lowest vacancy rate at just 7 percent, followed by New York City (midtown, midtown south and downtown combined) and Orange County, Calif., Dallas-Fort Worth and Detroit posted the highest major-market vacancy rates.
- Demand continued to outrun new supply by a wide margin in the first quarter, as it has for the past eight quarters. Net absorption of 14.0 million square feet, although modestly below the prior and year-ago quarters, was nearly three times the rate of space completions in the first quarter.
- Central business districts accounted for 30 percent of the space absorbed in the first quarter but just 9 percent of the space completed — the catalyst behind the sharper drop in the CBD vacancy rate compared to suburban markets.
- A new set of metropolitan markets rotated to the front of the pack in the first quarter, markets that were not absorption leaders in 2005. These included Chicago, Dallas, Houston and Atlanta as well as perennial top-performer Washington, D.C. This is a sign that economic growth has accelerated across a broader range of markets in early 2006.
- Space under construction crept up only slightly and remains well below recent levels of absorption, suggesting that markets will continue to tighten as the year progresses - particularly since high construction and labor costs and rising interest rates make it tough for developers to introduce new product.
- With 12.3 million square feet under way, Washington, DC and its Virginia and Maryland suburbs account for 21 percent of the total in the construction pipeline at the end of the first quarter.
Average asking rental rates continue to move higher, up by 7.2 percent and 3.6 percent for Class A and B space, respectively, over the past 12 months.
Sublease space declined for the 14th consecutive quarter to its lowest level in five years.
According to the analysis, questions abound about the investment side of real estate for the remainder of this year. Will high will interest rates rise? Will properties hold their value if capitalization rates follow interest rates higher? Are buyers paying too much and being too aggressive with their pro forma expectations?
But on the leasing side, there is no mystery. The office market is moving through a classic recovery cycle; absorption is strong, construction is modest, vacancy rates are falling, and rental rates are spiking in a small number of markets and at least stirring in most of the rest — with a few exceptions.
The economy is expected to add 2 million to 2.5 million net new jobs in 2006, enough to push the office market deeper into the recovery cycle and further toward the expansion cycle. But if the housing market stalls and the economy cools in late 2006 or 2007 as many analysts expect, the expansion phase of the office market cycle, a period when construction rises sharply, could be delayed. Expect leasing market conditions to shift gradually in favor of landlords over the next 12 to 18 months.
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