Office Space Demand Accelerates, Rising Supply has Rents Growing at a Decelerating Rate
CHICAGO – After a couple of lackluster quarters, the U.S. office sector rebounded in the second quarter in terms of net occupancy growth, according to Cushman & Wakefield. Nationally, rents continued to ascend to a new high, however, rising construction levels slowed the appreciation rate in most markets.
In the second quarter, absorption, the net change in occupied space, increased to 12.8 million square feet (msf), up from 6.3 msf in the first quarter and the highest level since the third quarter of 2016. In the first half of 2017, a total of 19.1 msf has been absorbed, roughly 60% of the pace of the first half of 2016. Of the 85 markets tracked by Cushman & Wakefield, 66 reported positive net absorption of office space, while 19 reported declines.
Kevin Thorpe, Cushman & Wakefield’s Chief Economist, says businesses remain confident enough to continue to expand their real estate needs.
“The labor market still has legs is the bottom line,” Thorpe said. “Even eight years into the cycle, office-using job creation remains healthy and solid in most markets. Moreover, the leading indicators, such as job openings, suggest that business expansion will remain healthy, and by extension, so will demand for office space.
“However, we have blown past full employment in certain cities, which means job growth is going to slow in certain spots and accelerate in others as businesses broaden their search for talent,” Thorpe continued. “This trend is becoming quite clear when we study this quarter’s office metrics. Secondary markets have a bit more labor slack and are now mostly powering the country’s absorption figures.”
The construction side of equation is also ramping up. In the second quarter, 16.1 msf of new office space was completed across the U.S., the largest amount of space completed since the second quarter of 2009. Cushman & Wakefield estimates that 2017 will see more than 71 msf of new office space completed, the most in a single year since 2008. Thus, despite the stronger absorption figures this quarter, U.S. vacancy rates remain flat at 13.3%. It also is notable and not unrelated that office rents are growing at a slower rate. U.S. office rents for all office product types were $30.36 in the second quarter of 2017, up 4.4% compared to the same quarter one-year ago. Although this rental appreciation remains healthy, it is slower than the 6.1% registered mid-2016.
“In historic terms, the U.S. office sector is generally not overbuilding office space,” said Ken McCarthy, Cushman & Wakefield Principal Economist and author of the report. “Construction levels are 30% lower than peak levels observed in the prior cycle and 60% lower than the levels observed during the Dotcom boom. Yes, certain cities are overdoing it, particularly the gateways and tech cities, but then again, there is still a strong tenant preference for new office product.
“I’m less concerned about the new space leasing up and more concerned about what this new supply means, particularly for the mid-quality product,” McCarthy continued. “This late in the cycle, growth isn’t going to be so robust that it bails everyone out, so it will continue to be a story of winners and losers. And given the construction dynamic, leverage is likely to tilt more earnestly towards the occupiers at this stage.”
In the second quarter of 2017, the top 10 absorption markets were: Dallas/Fort Worth (1.4 msf), Charlotte (1.1 msf), Seattle (940,000 sf), Raleigh/Durham (718,000 sf), Nashville (667,000 sf), Northern Virginia (650,000 sf), Baltimore (621,000 sf), Miami (483,000 sf), Atlanta (405,000 sf) and Phoenix (374,000 sf). In terms of new construction, the pipeline is concentrated in 11 markets, most of which have been among the strongest absorption markets in the current cycle: Atlanta, Boston, Charlotte, Dallas/Fort Worth, Denver, Manhattan, Northern Virginia, San Francisco, San Mateo, Seattle and Washington, DC. Together, these 11 markets account for 53.4 msf under construction, representing 49.4% of the total pipeline.
Nashville remained the tightest market in the nation with a 6.9% vacancy rate, followed by Midtown South Manhattan (7.5%) and Seattle (7.7%). The markets with the highest vacancy rate were Fairfield County, CT (23.2%), and Northern Virginia (20.8%). Markets with notable declines in vacancy were Charlotte (where vacancy fell 0.8% from the first quarter), followed by Inland Empire (0.6% decline) and Dallas/Fort Worth (0.5% decline).
Since national asking rent bottomed in the second quarter of 2011, average asking rents have increased 23.6%. The top 10 markets in terms of year-over-year rent growth in the second quarter were Oakland/East Bay (+16.1%), Palm Beach (+12.7%), Orange County, CA (+12.5%), Boston (+12.4%), St. Petersburg, FL (+10.7%), Nashville (+9.9%), Los Angeles (+9.4%), Austin (+8.7%) Jacksonville (+8.6%) and Baltimore (+8.3%).
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