Office Markets Look and Feel a Lot Better – But Higher Rents Still Some Way Off
The U.S. office market finished the year on a relatively strong note, with a sharp drop in vacancy and a healthy increase in occupied space. Rents continue to languish but the fourth quarter looks to be a key turning point. With the economy now posting robust growth, all that is needed for a full recovery is a surge in employment. Canadian markets also registered reasonably good growth, helping to round out a good quarter for North American office markets. With both the U.S. and Canadian economies back on more solid footing and the addition of private sector jobs, leasing markets are expected to continue improving as 2011 unfolds.
Fourth quarter data confirms our view that the U.S. office market has entered the recovery stage and will likely make continued progress, assuming the economy stays on the current path. Most encouraging is the twelve-month-long gain in private sector employment. Furthermore, office-using employment was reasonably strong during the October-December period, with professional and businesses employment in particular up 2.2 percent year-over-year. Widespread increases in rents are still unlikely anytime soon and any boost is likely to be presaged by a reduction in inducements, which have not materialized yet beyond a handful of markets.
U.S. office vacancy rate down sharply
The U.S. national office vacancy rate moved substantially lower during the fourth quarter, moving twenty-nine basis points lower (100 basis points equals one percent).
This represented the first drop after twelve quarters of rising vacancy. Office vacancies finished the quarter at 16.11 percent, almost certainly marking the beginning of a long decline in vacancy. During the fourth quarter, downtown vacancies decreased 23 basis points to register 14.81 percent, while suburban vacancy rates staged a slightly larger decrease, falling 32 basis points to register 16.69 percent. For the year, the U.S. national office vacancy rate fell 12 basis points after peaking in the third quarter. Canadian office vacancy rates were also down during the quarter, with central business district (CBD) vacancies falling 14 basis points to 7.02 percent while suburban vacancies decreased 8 basis points to 8.61 percent.
Office occupancies up for a third consecutive quarter
The most positive sign U.S. office markets are getting back on their feet is the third quarterly increase in occupied space. Fourth quarter absorption came in at 14.8 MSF (million square feet) which was a substantial increase from the third quarter when occupied space increased by 7.0 MSF. This brought full year absorption to 21.6 MSF, a considerable improvement from 2009 when occupied space shrank by 54.4 MSF. Examining fourth quarter absorption in detail shows 70 percent of newly occupied space was in Class A buildings, highlighting the continued move to quality by many tenants. Canadian markets also recorded an increase in occupied space during the fourth quarter with absorption totaling 2.3 MSF. For the year, Canadian office absorption totaled 7.4 MSF, compared with -1.1 MSF in 2009.
Rent picture again mixed
Fourth quarter data shows CBD rents increased a further 0.9 percent to average $39.30 per square foot, while suburban rents fell by a similar percentage to register $26.00 per square foot. Taking out the effects of some of the larger, higher-priced markets, both downtown and suburban rents fell during the quarter, falling 0.6 and 0.7 percent respectively. On a weighted basis, downtown rents fell 1.8 percent over the year while suburban rents dropped 2.9 percent during 2010. Canadian downtown office rents moved higher during the quarter with CBD quoted rents increasing 1.3 percent, while suburban rents increased 0.6 percent.
Office construction slows to a trickle
Fourth quarter office completions totaled just 3.8 MSF, the lowest total on record, and a further decrease from the third quarter when construction totaled 5.5 MSF. Going forward, office development will remain extremely subdued, reflected by construction activity which registered just 22.3 MSF at the end of the quarter. A year ago, construction underway registered 46.0 MSF. Completions may be in the process of bottoming out, but no sharp reversal is expected anytime soon. The Canadian office market also had very little new construction during the fourth quarter; however, downtown Toronto and Calgary had over 5.0 MSF under construction at year-end.