Demand for Office Space Still Subdued, But Q2 Better than Q1
The U.S. office market staged a modest rebound in the second quarter with stronger demand for space and a slight drop in vacancy. The much anticipated recovery in the U.S. office market, however, remains relatively restrained. Rents continued to languish as both downtown and suburban markets registered small decreases. With only modest economic growth in the first half of the year and employment showing disappointing gains, the outlook for the office space market is far from certain.
By comparison, Canadian markets enjoyed another reasonably good quarter on the back of a more robust economy and a healthier labor market. Both U.S. and Canadian economies are expected to strengthen in the second half of 2011, but projections made at the outset now appear overly optimistic. Given the sudden stall in job creation and continued high energy costs, the office market now faces a fairly stiff headwind that will likely put a damper on corporate expansion and add to inflation concerns.
Second-quarter data shows the U.S. office market recovery will continue to be uneven in nature and fairly volatile. New York, Washington, San Francisco and Seattle are the clear leaders in terms of demand; yet Boston, Dallas, Denver, Houston, Philadelphia, Raleigh, San Diego, San Jose, and West Los Angeles are all seeing modest gains in occupancy. Also somewhat positive is the seventeen month- long gain in private-sector employment. Furthermore, office-using employment was reasonably strong during the April-June period, with professional and business employment in particular up 2.9 percent year-over-year (June). Widespread increases in rents are unlikely to occur in 2011 and may not materialize until well into 2012.
Downtown markets push U.S. office vacancy rate lower. The U.S. national office vacancy rate fell slightly during the second quarter, shifting 12 basis points lower (100 basis points equals one percent) on a sharp drop in downtown vacancies. The U.S. office vacancy rate finished the quarter at 15.28 percent—back on track to finish the year below 15.00 percent. During the second quarter, downtown vacancies fell by 34 basis points to register 13.84 percent, while the suburban office vacancy rate held steady at 16.00 percent. Over the past 12 months, the U.S. national office vacancy rate has fallen 36 basis points. This quarter, the flight to quality was particularly evident in Class A vacancies, which shrunk 28 basis points. Canadian office vacancy rates fell in most markets with central business district (CBD) vacancies falling 65 basis points to 6.13 percent, and suburban vacancies decreasing 32 basis points to 8.46 percent.
Office absorption positive for fifth consecutive quarter. The U.S. office market registered a fifth consecutive quarter of rising occupancy. Second quarter absorption came in at 9.9 million square feet (MSF)—a significant improvement from the first quarter when occupied space increased by 4.2 MSF, and slightly more than twice the absorption recorded a year ago when occupied space expanded by 4.9 MSF. Continuing a trend seen over the past few quarters, Class A buildings continued to attract “move-up” tenants: Class A absorption totaled 8.5 MSF, or nearly 86 percent of overall absorption. Canadian markets also recorded an increase in occupied space during the second quarter, with absorption totaling 3.6 MSF. This was a healthy increase from the 2.6 MSF recorded in the first quarter.
Rents take a further down-leg after showing signs of stabilizing. After a small increase in the first quarter, both CBD and suburban rents drifted lower in the most recent three-month period. Second-quarter data shows Class A CBD rents decreased by 1.5 percent to average $38.98 per square foot. Class A suburban also moved lower, dropping 0.7 percent to average $26.06 per square foot. Of the 57 downtown markets tracked, 30 saw rents decrease, 20 saw rents increase and seven held steady. In the 58 suburban markets tracked, rents dropped in 28, rose in 24, and held steady in the remaining six. Canadian downtown office rents moved higher during Q1 with Class A CBD rents increasing 0.4 percent while suburban Class A rents decreased 1.3 percent.
Office construction returns to record-low levels. After a modest increase in the first quarter, second-quarter office completions totaled just 3.9 MSF— returning to levels recorded during the fourth quarter of 2010. It should also be noted that just four markets accounted for almost 60 percent of Q2 new supply: downtown Houston (845,000 SF), downtown Seattle (600,000 SF), suburban Baltimore (425,000 SF), and suburban Miami (422,000 SF). Construction underway increased by almost 14 MSF relative to the first quarter, with 39.4 MSF in various stages of development at the end of the second quarter. Most of this increase was due to construction associated with the World Trade Center site in Lower Manhattan. The Canadian office market had a modest level of new construction during the second quarter, adding 1.1 MSF square feet with another 7.0 MSF underway.