A recessionary mindset is squeezing the office market.
national office leasing market that emerged from the recession was a vastly
different animal than the one that entered it in 2008. The years of downturn
transformed how corporate tenants around the country define their use of space,
and that fact has contributed to a leasing recovery that, while progressing,
has to date been slower than other areas of commercial real estate. For
comparison, just look at the capital markets, which by most accounts are fully
back on track.
mistake. Leasing has stabilized, to the point that some regions even boast
construction starts to absorb the demand. What’s more, as the recovery
continues to take hold, corporate America is beginning to move beyond its
doing-more-with-less mentality to start doing more with, well, more. That means
numbers have been disappointing,” says Hessam Nadji, senior vice president and
chief strategy officer for Calabasas, Calif.-based Marcus & Millichap. “But
the No. 1 job-creating structure in the U.S. since the recession has been
professional and business services.” In fact, Nadji points out there have been
nearly 700,000 jobs added in this sector during the past 12 months.
Nevertheless, the office vacancy decline has been minimal. Why?
leaves a permanent mark,” Nadji says. “Leasing was very aggressive during the
growth cycle. The permanent mark from this recession is a reversal of that — an
ultra-conservatism about space utilization — and it is here to stay. Tenants
are completely rethinking their use of office space with the goal of consuming
less space and becoming more efficient.”
squeeze is definitely on. According to CoreNet Global research, the average
square foot per person dropped from 225 square feet to 176 sf between 2010 and
2012. That is expected to shrink to 100 sf by 2017.
Eckert, a CBRE vice president in Kansas City, Mo., sees that dynamic playing
out daily. “Our clients are looking very closely at how much space they use,”
he reports. “Some of the larger law-firm tenant improvement projects currently
underway here reflect a reduction in office sizes of roughly 33 percent.”
Nadji believes that many corporate offices have reached capacity. “The worst of
this disconnect between job growth and space consumption is over,” he notes.
“More companies are looking at the need to grow.”
is seeing that as well in Kansas City, reporting that CBD vacancies are
whittling down, due both to a hike in leasing and a conversion of older office
assets to residential use. “The CBD/Crown Center market is at 21.6 percent
vacancy with little differential between class A and B product,” he reports.
The vacant inventory got a big boost when the General Services Administration
selected Two Pershing for its 150,000-sf requirement late last year, “as well
as from a handful of long-standing office buildings that have announced a
stand at the tipping point between stabilization and full-bore recovery, the
leasing market seems almost bipolar. CCIMs we talked with express both
post-recession highs and, if not lows, at least concern about what the next
months will bring, sometimes both in the same market.
getting better, but it’s slow and we’re moving at glacial speed,” says Thomas
C. Aguer, CCIM, SIOR, president of NAI Aguer Havelock in Sacramento, Calif.
Ironically, that’s a vastly different picture than the one taking place in
white-hot San Francisco, just 90 miles to the west, or even the suburb of
Roseville, Calif., a mere 20 miles to the east.
Sacramento, “We’re seeing the private sector generally squeezing more people
into less space, creating extremely high headcounts,” he says. “Sacramento
rents are running at $21 psf to just over $22 psf per year with the CBD topping
out at $24 psf.” By comparison, along Roseville’s Douglas Boulevard, rents can
match the Sacramento CBD.
is another metro area with one foot in stabilization and another in growth.
Andrew Cheney, CCIM, SIOR, a principal at Lee & Associates, reports that in
the Chandler and Tempe, Ariz., submarkets, there is actually office
construction taking place, to the tune of nearly 2 million sf, 18 percent of
which is spec. And yet, the overall vacancy “is still 22 percent, causing
downward pressure on rents.”
predicts that if the market can absorb at least 2million sf this year,
“we’ll break into the 19 percent vacancy range and begin to see a different
Phoenix officemarket.” That’s highly doable if the market can continue to
attract deals such as the one forged with Rural Metro, a national provider of
private ambulance and fire-protection services. Rural took 90,000 sf in the
Pima Office Pavilion in Scottsdale, Ariz., making it the largest lease of the
first quarter. “We have some wind at our backs. Let’s see how strong it stays,”
despite such mixed reviews, building values have continued to increase. But
that’s not likely to continue until leasing catches up. (See Investment
sidebar.) Happily, that time is near at hand.
are two market cycles that don’t necessarily speak to each other,” says Dan
Fasulo, managing director of New York City-based Real Capital Analytics. “There
are the leasing markets, and then there are the capital markets. The capital
markets have basically seen a full recovery from the downturn. The space
markets have not.” However, Fasulo is quick to acknowledge that rents are
starting to rise and vacancies dip. He says that this is due in part to the
fact that “we haven’t built anything in five years.” (See Pipeline sidebar.)
Cities Take the Investment
investors searching for yield are starting to look beyond the country’s
top-tier cities. Real Capital Analytics managing director Dan Fasulo describes
the pull of capital away from gateway cities such as New York and San Francisco
as “almost like gravity” to the opportunities found in Atlanta (which ranked
No. 6 in RCA’s 2013 list of Top 40 markets with $10.6 billion in sales); San
Jose, Calif. (No. 10 with $7.3 billion); or Denver (No. 12 with $6.8 billion).
are REIT or a pension fund,” says Fasulo, “you need a certain going-in yield to
return what you promised your capital providers. And you can’t do that in
don’t fret for the major markets. Manhattan still ranked first on the list,
with $36.3 billion; Los Angeles came in second at $24.5 billion; and Chicago
third at $14.5 billion.
overall basis, sales of what RCA terms “significant” office properties totaled
$22.6 billion in the first three months of 2014, a 31 percent jump
year-over-year. In addition, “Prices continued to strengthen and cap rates
trended lower,” the report revealed.
sales volume was up significantly for the nation’s CBDs, but not so much for
the suburbs. CBD volume was up 60 percent in 1Q14, RCA reports, while in the
suburbs it increased 10 percent. “Nationally, average cap rates moved sharply
lower for CBD properties while the suburban average was relatively unchanged,”
the report states. “Top quartile cap rates declined 25 basis points for both
and currently average 4.8 percent for CBD and 6.3 percent for suburban.”
hungry for higher yield, are going to be challenged to wring more from their
assets. “That game is over,” Fasulo says. “The capital is already here, and
interest rates are at an all-time low. You can’t get any more money from that
part of the equation. So the space markets are going to become an increasingly
important factor in the increase of prices. You’re going to have to get higher
rents and you’re going to have to have fully leased office buildings.”
statistics reveal the slow transition of leasing from stabilization to growth.
Reis reports that the national vacancy rate fell to 16.8 percent in first
quarter 2014, a 10 basis-point decline from 4Q13. Since vacancies peaked at
17.6 percent in 2010, there hasn’t been a decline larger than that.
Reis’s top 82 markets, only 24 had a 1Q14 vacancy rate below 16 percent. For
the most part, these were the obvious choices, the major gateway cities, such
as Washington, D.C., at 9.7 percent; New York City, which logged in at 9.9
percent; and San Francisco at 12.8 percent.
32 of the markets, many of them secondary and smaller, showed a 20 bp to 90 bp
drop in vacancy rates from 4Q13 to 1Q14, and several had significant YOY
vacancy rate drops, including Charleston, S.C. (-140 bp), Colorado Springs
(-160 bp), Palm Beach, Fla. (-200 bp), and Portland, Ore. (-110 bp), indicating
a broadening of the recovery.
dynamic holds true in rental rates. Rents have risen now for 14 consecutive
quarters, totaling a 1.6 percent increase in 2011, 1.8 percent in 2012, and 2.1
percent last year. Asking and effective rents on a national basis grew by 0.7
percent and 0.8 percent respectively in 1Q14, Reis reports. The top three
cities in 1Q14 rates were, again, New York at $62.30, which edged out
Washington, D.C., at $50.58, and San Francisco at $44.68.
driving the uptick in leasing? Technology and energy companies were the prime
drivers of these reductions in “eight of the top 10 markets ranked by effective
rent growth,” says Reis vice president of research and economics Victor Calanog
in the firm’s 1Q14 First Glance report. These include San Jose, Calif.; San
Francisco; Dallas; New York; Austin, Texas; Seattle; and Oklahoma City.
Capital Analytics is located in Manhattan’s Midtown South, a traditionally
lackluster submarket hidden in the shadow of always-hot Midtown. Today Midtown
South is a tech hub and one of a couple of Big Apple neighborhoods that calls
itself Silicon Alley. Fasulo reports that “Prices are maybe 50 percent above
peak levels. It’s really gotten very hot very quickly.”
Google, which helped establish New York’s tech hub in 2010 by buying 111 Eighth
Ave. for $1.8 billion, is reported to be looking for as much as 600,000 sf of
additional space in Midtown South.
R. Johnson, SIOR, MCR, CCIM, a principal in the Charleston, S.C., office of
Colliers International, reports that tech-related groups indeed dominate. Tech
firms and defense contractors, he says, have been signing the larger deals,
between 20,000 sf and 40,000 sf.
But on a
national basis the after-effects of the recession still linger, even as markets
pick up. “Landlords appear to have little leverage over tenants,” Calanog
writes. “With concession packages being pulled back very slowly, effective rent
growth is not much faster than asking rent growth.”
news here is that, if Nadji’s theory proves true (and barring any surprises in
the economic picture), more office-filling jobs are on the horizon. At some
point the firms stuffing workers into available space will have to call their
brokers once again.
says that’s a possibility this year. “If the predicted monthly average of
200,000 to 250,000 jobs for the year does come to fruition,” he writes, “we
fully expect to record the first meaningful acceleration in vacancy declines
and rent growth this year.”
result, he’s predicting a 3.0 percent jump in asking rents and a 3.5 percent
hike in effective rents. And no economic surprises — so far — “have caused us
to alter our outlook significantly.”
Salustri is an award-winning freelance journalist who has covered the
commercial real estate market for more than 25 years.
Pipeline Waits for Fundamentals
the commercial real estate sectors, construction is the last to recover. “Lack
of demand will have lowered rent levels and operating income, and slackened
space utilization will make it harder to lease up existing assets,” says Arthur
Jones, senior managing economist at CBRE Econometric Advisors in Boston. Plus
new builds can take up to five years to lease up, putting the sensible money on
shoring up existing assets with in-place revenues.
characterizes the current pipeline as “relatively subdued, but changing.” That
change is a reflection of the recovering fundamentals, leading to a
construction pipeline that is “moderate and drawn out in comparison to
still take some time before a national construction boom can be declared, given
the spotty nature of those fundamentals. “Most markets are not ready to support
construction levels anywhere near their historical norms,” he says. “With rents
well below their replacement-cost thresholds, in many markets it makes more
sense for capital to pursue existing assets than to assume the risk of
developing and leasing up from scratch.”
are exceptions, and for the most part these follow the new age of leasing
trends with a focus on tech in such cities as Austin, Texas; San Francisco; and
San Jose, Calif.; and energy in places like Houston. Then there’s the nearly
constant draw of the gateways, such as Boston and New York, neither of which,
Jones points out, can be clearly defined as energy or tech hubs. “They have
strong fundamentals and highlight a trend among more mature markets in which a
combination of older stock and demand for modern space is pushing development
into underdeveloped and underutilized submarkets.” Going forward, Jones sees
moderation as the watchword for new builds.