U.S. Office Sector Enjoys Steady Leasing Momentum

U.S. Office Sector Enjoys Steady Leasing Momentum

U.S. Office Sector Enjoys Steady Leasing Momentum

Availability of Prime Office Space Increasingly in Limited Supply as Majority of Markets See Vacancy Declines

The U.S. office market continued its steady momentum in the second quarter, recording 39.4 million square feet of net absorption in the first six months of 2016, nearly equaling the 40.2 million square feet absorbed during the record-setting first half of last year.

The U.S. office vacancy rate ticked down another 15 basis points to 10.6% in the second quarter of 2016, well below the long-term historical vacancy rate of 11.3%. CoStar analysts expect the office vacancy rate to continue trending lower before bottoming out at around 10.2% in 2018, about the same as lowest point of the last real estate cycle.

“Basically, we expect to have two more years of occupancy recovery in the office market,” noted Walter Page, CoStar’s director of office research, who presented the Mid-Year 2016 Office Review and Forecast along with Hans Nordby, managing director for CoStar Portfolio Strategy and CoStar senior real estate economist Paul Leonard.

Several markets showed marked improvement at mid-year, including ones that were previously struggling, such as Phoenix, which posted positive absorption of 3.4 million square feet.

In Seattle, which has enjoyed a particularly strong run, Amazon’s ongoing expansion helped drive 3.1 million square feet in net absorption. Even Washington DC saw a welcome return of strength in the second quarter after several years of flat demand growth. The D.C. office market absorbed a respectable 2.3 million square feet over the last four quarters.

“Finally, we’re starting to see some momentum in the D.C. marketplace, which should allow the vacancy numbers to start inching downward,” said Page.

There were several notable exceptions. The energy sector slowdown and corporate relocations related to the completion of several pending build-to-suit projects played a role in Houston and Dallas, which recorded absorption declines of 2.4 million and 3.7 million square feet, respectively, since mid-year 2015. San Francisco, Raleigh, Boston and San Diego also logged declines due to a variety of factors.

But for the most part, the vast majority of office submarkets — 66% — saw their office vacancy decline in the second quarter, and more than half of all U.S. office submarkets have a lower vacancy rate than during the previous market peak in 2006-2007.

Demand for High Quality Space Resulting in Limited Supply

In a theme seen in many markets across the country, the supply of available space in newer, higher-quality office buildings is becoming increasingly limited. With relatively little new development in the pipeline based on historical levels, only about 81 million square feet of space is available today in buildings constructed over the last 10 years.

That total is less than half the 167 million square feet of vacant newer space that was available in 2007, according to CoStar’s analysis.

“While there are some exceptions where plenty of high quality, new office space remains available, such as Houston and Washington, DC, for the most part we’re really tight on nice, new space,” noted Page.

As evidence, Page noted that the vacancy rate for 4- and 5-Star office properties remained unchanged at 11.7%, despite the fact that 90% of the new office space added to the market falls into that category.

Suburban office markets also continued to see increasing activity as large blocks of high-quality space become harder to find — and more expensive — in most major markets, with the exception of Los Angeles, Seattle, Chicago and Atlanta, where large blocks of downtown space remain readily available.

“Part of the story is that it’s now the suburbs’ turn in the cycle, and part of it is that the CBDs were so successful earlier in the recovery cycle that there’s no place left to grow,” Nordby said.

As investors begin to focus on which markets are the most recession-resistant in the later innings of the recovery, certain niches such as medical office space stand out, Nordby said.

Demand growth is nearly twice as strong for medical office as for regular office, and over the long term, medical office has grown at about 1.3% annual rate compared to 0.7% for the broader office market, Page said. The medical office sector, which has never had negative demand growth, even during the two recessionary periods since 2000, had a midyear vacancy rate of 8% compared to the broader market’s 10.6%.

Office construction stayed flat in the second quarter at about 130 million square feet under way, due in part of a large decline in Houston. But building activity is still slightly above its long-term average of 125 million square feet, with increased construction in D.C. and Atlanta, among other metros.

Some Cautionary Yellow Flags

While leasing and absorption levels remain robust and construction still well below historic levels, the U.S. office market did see some cautionary flags in the second quarter, including a big slowdown in office sales activity and the beginning of a slowdown in rent growth.

CoStar is projecting office rent growth will likely finish the year at an average of 3.4% and decelerate to the low 3% range over the next year. As with all trends, there will likely be a few exceptions, including the Nashville, Atlanta and Florida markets, where lower rents earlier in the cycle have limited construction. Also, rent growth in CBDs is expected to continue to outpace suburban markets.

Meanwhile, reflecting declines across all the property types, the volume of office sales completed in the first half of 2016 declined compared to the same period one year earlier, according to preliminary CoStar data.

“It’s a worry,” Nordby said. “A decrease in transaction volume generally portends a decrease or at least a flattening in prices.”

And in another historical sign of softening demand, rising levels of surplus space placed on the sublease market by tenants, is rising in a few markets. In Houston, the contraction of large energy tenants has caused sublet space to balloon to more than 3.5% of total inventory. Companies such as Shell, ConocoPhillips, and BP have each put 500,000 square feet on the sublet market in recent quarters.

Source: CoStar Randyl Drummer July 27, 2016

Post-Brexit Foreign Investor Flight Expected to Boost U.S. Office Sales

Post-Brexit Foreign Investor Flight Expected to Boost U.S. Office Sales

Post-Brexit Foreign Investor Flight Expected to Boost U.S. Office Sales

Midyear Update: Defensive Portfolio Repositioning May Benefit U.S. Property Market in Second Half of 2016

The U.S. office market continued to record strong demand as measured in both occupancy and rent growth at midyear, and analysts even found optimism in the slowing trend in investment sales activity seen year-to-date.

Office net absorption rebounded from a slow first quarter, matching year-earlier levels, and vacancies continue to fall to a cyclical low in the second quarter of 2016. Although easing slightly this year, office rent growth ended the quarter with a strong 4% increase, according to Walter Page, director of U.S. Research, Office for CoStar. First-half office sales were down 20% from the same period last year, largely reflecting the smaller pools of buyers for marketed properties and diminished investor appetite for higher-risk assets, Page said.

“While the 10-year Treasury rate has hit a record low, our view is that cap rates for real estate in general are likely to remain fairly flat,” said Page, who will elaborate on office market trends in CoStar’s Midyear 2016 Office Market Review and Forecast presentation on July 21.

The generally optimistic views of the U.S. office market were shared by others, including Colliers International Chief Economist Andrew Nelson, who said investment sales activity in the office sector remains at healthy levels relative to historical averages, and could see a further boost from the recent Brexit vote.

“U.S. property markets could benefit from potential capital flight out of Britain and Europe generally, in part as a response to last month’s Brexit from the European Community,” Nelson said.

Evidence is beginning to emerge of an uptick in foreign buyers seeking the security and economic stability of U.S. office and other commercial property markets, including warehouse, as a result of the Brexit. And some of those international bidders and buyers are popping up in markets outside the DC/New York City/San Francisco triangle, such as downtown Chicago and Austin.

In one instance, a number of foreign bidders were reported to have put in offers for 1K Fulton, a 10-story, 531,190-square-foot Class A office building that serves as Google’s Midwest headquarters in Chicago. American Realty Advisors beat out others to buy the property from Sterling Bay for a reported $257 million.

Martha Shelley, senior portfolio manager for American Realty, said the deal is an example of defensive positioning of its portfolio by investing in core assets in major markets.

“We believe that this is the most effective approach at this point in the market cycle,” Shelley said. “We were attracted this asset because it has long-term leases with quality tenants such as Google.”

Foreign Capital Can Also Play Good Defense In US CRE

There is also mounting evidence that events in Europe and around the world are making U.S. property more appealing to investors interested in pursuing similar defensive strategies.

“Shortly after Brexit, I received several calls from international investors seeking more information about Texas commercial real estate,” says Jim Young, CCIM, a broker at Longbow Real Estate Group in Austin. “Several U.K. investors tell me that they see U.S. real estate as a safe haven. Given low interest rates on commercial real estate loans, and commercial rental rates in Central Texas that continue to rise, I expect there will be even more of an uptick in European and global investor activity,” Young added.

Capital flows into the office sector remains strong and interest in top-quality properties with stable tenancies and minimal lease rollover risk remains high.

While institutional investors remain focused on core property in major markets, more risk-tolerant investors are targeting assets with re-leasing opportunities.

While a decrease in office sales was expected this year following 2015’s breakneck pace, steady debt and equity flows and improving asset performance have continued to generate steady sales activity, and investors continue to see upside potential in office properties, which are the only major property type that has yet to reach pre-recession peak pricing levels.

Broad-based employment gains among people who work in offices, with more job growth expected this year, should continue to push office performance. Urban and suburban office markets will likely continue to draw investor attention as yields in other property options have tightened significantly.

Average office pricing has risen nominally from a year ago, while the average cap rate was essentially unchanged in the low-7% range. Office investors saw a slight rise in first-year returns in primary markets, contributing to a narrower spread between cap rates in tertiary markets.

Tenant demand kept pace with new office construction despite a deceleration in the first half of the year linked to the growing economic uncertainty.

“U.S. businesses have had many curveballs thrown at them this year. Concerns over the health of China’s economy, equity market volatility, weak U.S. GDP growth, now Brexit – many reasons to at least tap the brakes on expansion plans,” Thorpe said. “But overall, the office leasing fundamentals are holding up extremely well, and the secondary markets are really starting to hit their stride.”

Source: CoStar Randyl Drummer July 14, 2016

U.S. Office Sector Enjoys Steady Leasing Momentum

Q4 2015 Office Trends

Q4 2015 Office Trends

National Office Market

National vacancies fell by 20 basis points in the fourth quarter, ending the year at 16.3 percent. The 20 basis point decline in vacancies is, though quite modest based on historical standards, the greatest pace of improvement in fundamentals for the office sector since the recovery began in 2010. Overall, vacancies fell by 40 basis points in all of 2015, suggesting that momentum in office fundamentals is building.

Asking and effective rents both grew by 0.8 percent in the fourth quarter and by 3.1 and 3.2 percent, respectively, throughout 2015. That is the best annual performance for asking and effective rents since the recession; the recovery for office properties has very much mirrored the slow growth of the overall economy, and it’s a shame that now that office fundamentals appear to be improving better – we appear to be running into more economic headwinds.



Supply and Demand Trends

Q4 2015 Office Trends: The good news is, despite a murkier outlook for the domestic economy, we see much less supply growth for office markets that might lower expectations even further. The economy growing by 2.0 to 2.2 percent, creating jobs in the low 200s, on average per month, would augur well for office fundamentals. Our estimate of office-using employment has risen faster than nonfarm employment for the last couple of years, and we expect that trend to continue.

As it stands, our projections of vacancy rates falling gradually over the next five years are conservative. We expect to hit the 14s at the end of the forecast period, and if historical patterns hold true it is only below that figure that asking and effective rents can really start to take off.

Source: REIS Victor Calanog on Feb 23, 2016

Office Market Reaches Supply Demand Sweet Spot

Office Market Reaches Supply Demand Sweet Spot

Office Market Reaches Supply Demand Sweet Spot

U.S. office market demand growth rebounded in the second quarter of 2015 following slower-than-expected net absorption in the first three months of the year as businesses continued to add office jobs and lease space.

Net absorption roared to 25 million square feet in the second quarter, the second-highest quarter for demand growth since 2006 and more than double the 12 million square feet absorbed during the first quarter.

After years of slow and steady increase in office supply, the level of office space under construction reached 124 million square feet in the second quarter, the highest total since 2009 and slightly eclipsing the 15-year average of 122 million square feet.

Rent growth reached s 4% annual rate in the first half of 2015, while the national office vacancy rate declined 20 basis points to 11.2%. The 27 million square feet of new office space deliveries in the first half of 2015 exceeded the historical first-half average of 21 million square feet, reflecting a relatively healthy office market and broader economy.

“We’re at a supply/demand balance — a really sweet spot in the market cycle for the office market,” said Walter Page, CoStar Group, Inc. director of U.S. research, office, joined by Senior Manager, Market Analytics Aaron Jodka and Managing Director Hans Nordby for CoStar’s State of the U.S. Office Market Midyear 2015 Review and Forecast.

An all-time high of 63% of the 2,000 U.S. office submarkets tracked by CoStar now show improving vacancies, with 48% of the metro markets now showing lower vacancy than at the peak of the market during 2006-07. Vacancies are now dropping across the board, even among 3-Star office properties, a sign that recovery is accelerating in the lower end of the office quality spectrum.

That said, tenants continue to demand higher-quality space. Year-over-year demand growth remains weak at 0.6% for 3-Star buildings, compared to 2.4% for 4- and 5-Star buildings, with tenants willing to pay a 41% rent premium for newer, higher-end buildings over lesser 3-Star assets.

“Tenants want newer, nicer space and they’re willing to pay for it,” Jodka said.

Source: CoStar Randyl Drummer July 22, 2015

Office Trends Q4 2013

REIS Reports: Q4 2013 Office Trends, Office properties continued to recover, and the retail market showed its first signs of improvement.


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