Despite Many Signs of Economic Revival, Office Markets Still Drifting Lower
While the economy, and to an extent leasing activity, improved markedly during the first quarter, market fundamentals continued to weaken. Both Canadian and U.S. vacancies rose, although the latest increases were relatively muted. Demand was mixed with the U.S. market recording negative absorption while Canadian markets recorded modest growth. With both the U.S. and Canadian economies posting relatively robust growth in the first quarter and a more upbeat labor market, leasing markets are expected to improve in the coming quarters but not to the extent market fundamentals will shift dramatically before 2011.
The first half of 2010 is shaping up to be a period of transition from dramatically rising vacancies and falling rents to more modest movements in both and a projected reversal by the third quarter. With U.S. vacancies now set to peak near 16.5 percent, tenants with leases expiring in the near term will have a plethora of choices; however, if the economy continues to recover strongly and virtually no construction coming online, this window of opportunity could be very short.
Vacancies creep higher in the first quarter.
The U.S. national office vacancy rate moved slightly higher during the first quarter, marking the tenth consecutive quarterly increase. The overall vacancy rate increased 16 basis points to register 16.39 percent. U.S. office vacancies are now back to levels last recorded during the first quarter of 2004. During Q1 the Downtown vacancy rate increased 20 basis points to register 14.75 percent while suburban vacancies increased 15 basis points to 17.11 percent. Canadian vacancy rates also moved higher with CBD vacancies rising 29 basis points to 7.04 percent compared with suburban vacancies which increased 26 basis points to 9.02 percent.
Office tenants return more space to the market.
First quarter absorption was again negative, with occupied space contracting by 5.4 MSF (million square feet). This was the ninth consecutive quarter of contraction but was a significant improvement from a year ago, when absorption was -25.3 MSF, and only marginally worse than Q4 2009 when occupied space fell by 3.1 MSF. Companies are showing increasing signs they are comfortable with the space they currently occupy; however, in terms of additional office lease-up, it is highly unlikely any increase will occur in the near term. By contrast Canadian markets recorded an increase in occupied space, with absorption totaling 1.4 MSF.
Rents continue to drift lower.
Extending a near two year trend, office rents continued to decline, albeit by only a small percentage. For the seventh consecutive quarter, downtown lease rates dropped with Q1 Class A asking rents dipping by 0.3% to $37.60 per square foot. This marked the smallest decline since rents began to drop 21 months ago. Suburban asking rents also fell during the quarter, dropping 0.8% to $26.64 per square foot. This marked the eighth consecutive decline for suburban rents. Year-over-year CBD rents were down 13.3% while suburban rents were down 3.8%. Office rents in Canada were mixed with CBD rents declining 1.4% during the quarter while suburban rents moved 0.6% higher.
Office development posts modest increase but trend still down.
First quarter office completions totaled 13.0 MSF, a slight increase from the fourth quarter, when construction totaled just 9.9 MSF, but was down from a year ago when 15.4 MSF was brought to the market. Construction activity, however, continued to decline with Q1 under construction falling to just 30.7 MSF, compared with 46.0 MSF at the beginning of the quarter and well below the 120 MSF underway at midyear 2008. Construction is expected to dwindle as the year progresses. With the exception of just a few build-to-suits, new office development will be largely absent from the U.S. office landscape by year-end.