What Trends Bode Well for the Office Market in 2013?
North American office vacancy decreased for the fifth consecutive quarter in Q1 2013, albeit at a modest rate according to the latest North American Office Report from Colliers International. Among the 87 U.S. and Canadian markets tracked by Colliers, the vacancy rate improved to 13.89% in Q1 2013, down from 13.91% in Q4 2012.
In both the U.S. and Canada, the suburban vacancy rate decreased on a quarter-over-quarter basis, while the CBD vacancy rate rose in both countries. Absorption slowed to 7.8 million square feet in Q1 2013, about 37% of the Q4 2012 total of more than 21.1 million square feet, reflecting robust tenant demand in Q4 2012 and the impact of the sequester and tax increases.
Transaction activity also took a step back this quarter, totaling $16.1 billion compared with $31.0 billion in Q4 2012. However, investment activity picked up late in the quarter, with more than half of the quarterly sales volume occurring in March, and should increase further during the remainder of 2013.
Construction activity remains near record lows and generally is concentrated in areas with particularly strong demand, including San Francisco, San Jose, Houston, Boston and New York. Also, about 30% of current construction is in the medical office sub-type. Low levels of new construction will remain a key supply-side driver of office recovery during the next few years.
Below are a few key takeaways from the report:
- The U.S. economy has recovered about 70% of jobs lost during the recession as of April 2013, and total employment in Canada is about 500,000 jobs higher than the pre-recession peak. Continued job growth in the primary office-using employment sectors is driving improvement in the office markets of both countries. In general, the Canadian office market is much tighter than in the U.S.; the six North American markets with the lowest vacancy rates in Q1 2013 were in Canada.
- A continuation of the trend during the last few years, intellectual capital, energy and education (ICEE) markets outperformed during Q1 2013, with +3.9 million square feet of absorption compared with -8,000 square feet of absorption in FIRE markets.
- More efficient use of office space is resulting in lower absorption than would have occurred in the past given the number of office-using jobs created during the current recovery. Flexible and collaborative space preferences among some tenants, particularly in the technology and other creative industries, as well as reduced need for physical storage and some administrative functions, such as at law firms, are contributing to this long-term shift. However, the “densification” of employees is more difficult in suburban locations not served by public transit because of pre-existing parking ratios.
- Very low levels of construction activity have been and will continue to be a key driver of the office market’s recovery. Most of the space currently under construction is in an ICEE market and/or already has had a significant amount of pre-leasing. Also, about 30% of office construction is medical office.
- Office transaction activity during Q1 2013 was about half of the total in Q4 2012, constrained by tax increases as well as fears regarding the sequester, weakness in the Eurozone and volatile U.S. economic data. However, about half of the Q1 2013 volume occurred in March, and we expect transaction volume to increase during the remainder of the year, bolstered by greater confidence in the economic recovery and investor search for yield in the current low interest rate environment.
- Cap rates continue to vary significantly by location, ranging from an average of 6.0% for CBD office properties to 7.8% for office properties in tertiary markets. Given the economic recovery, large amount of dry powder on the sidelines and desire for yield, investor demand and risk tolerance will rise, spreading to less favored markets. Office investment continues to offer an attractive risk-adjusted return given artificially-low interest rates.
You can view the full report here.