As U.S. Office Market Stabilizes, Will Rents Soar or Taper?
Despite slowing demand in cities such as Boston and San Francisco, occupancies and rental rates remain strong nationwide, observers say.
During the height of the recent tech boom, landlord Peter Moglia marveled as surging demand for office space drove up rents in San Francisco by nearly 40 percent in two years. Moglia is CIO of Alexandria Real Estate Equities, a Pasadena, California–based firm that late last year signed mobile payments processor Stripe to a 300,000-square-foot office lease in San Francisco’s South of Market neighborhood, the city’s largest office transaction of 2015.
But the pace of rent growth in technology hubs like the Bay Area and Boston has cooled as demand has tempered, says Moglia, whose REIT owns 18 million square feet of offices and laboratory space, nearly half of it in those two cities. “Overall, we think things are stabilizing,” he says.
Tenant demand for office space slowed in the first quarter of 2016, reflecting weakness in the energy industry and a cooling in the tech sector, real estate services firm Cushman & Wakefield reports. Net absorption of U.S. office space fell to 9.7 million square feet, down 59 percent from the fourth quarter of 2015 and off 43 percent from the same period a year ago, according to the Chicago-based firm. Absorption was especially weak in Boston, New York and Silicon Valley.
Demand for U.S. office space still generally outpaces supply, and real estate experts predict that rents overall will rise in 2016, although they disagree on how much.
In cities in which demand is slowing, the office market faces a soft landing, rather than a crash, contends Kevin Thorpe, Cushman & Wakefield’s chief economist. “The air is sort of slowly seeping out of the balloon,” he says. “That’s all that has happened so far. And, quite candidly, I’d say that was what needed to happen.”
Nationally, Cushman & Wakefield reports, office rents averaged $28.45 a square foot as of March 31, up 4.1 percent from a year earlier, moderating from the 5 percent year-over-year growth rate of March 2015. In the latest quarter, rents rose in 67 of the 87 markets tracked by the firm.
Midtown Manhattan had the country’s most expensive lease rates, at $78.42 a square foot, up 4 percent from the first quarter of 2015. Tech mecca San Jose, California, posted a 22 percent year-over-year increase in office rental rates for the first quarter, the fastest pace in the nation. By contrast, first-quarter rents rose a modest 2.9 percent from a year earlier in Houston, which has been hit hard by the slump in the energy sector, whereas Boston’s increase was just 1.7 percent, according to Cushman & Wakefield.
Landlords are enjoying something of a Goldilocks moment, real estate watchers suggest, with demand brisk but not vigorous enough to spur a building boom that would inevitably drive down returns. Occupancies and rental rates are strong in most areas.
Among the 87 metropolitan areas surveyed, 54 reported positive demand for office space in the first quarter. Downtown New York was the weakest market in Cushman & Wakefield’s study, suffering negative absorption to the tune of 632,289 square feet. Boston, a victim of the tech slowdown, was another poor performer, with tenant departures exceeding move-ins by 522,642 square feet.
Watch This SpaceThe 87 U.S. office markets tracked by real estate brokerage Cushman & Wakefield showed a dramatic contrast in
absorption, or space newly occupied and vacated, during the
first quarter of 2016.
|83||New York – Midtown||–0.426|
|87||New York – Downtown||–0.632|
|Source: Cushman & Wakefield.|
Although tech hubs and the oil patch cooled, the Dallas–Fort Worth metro area was the country’s hottest office market. It saw absorption of 2.15 million square feet, and rents rose nearly 18 percent from a year ago. “Dallas has a lot going for it,” Thorpe says. “People and businesses are moving there. It’s a distribution hub. And Dallas does not have the exposure to the energy sector like some of the other cities in Texas.”
The U.S. office market has been buoyed by robust job growth over the past year. During the 12 months ended this March, employers added an average of 233,500 jobs a month, according to the Department of Labor.
“The U.S. economy remains a jobs-producing juggernaut, and close to 30 percent of the jobs being created are office-using,” Thorpe says. “At the same time, the supply side of the equation — new construction — continues to lag behind.”
Financing is the wild card: Chastened by strict lending standards, developers have been cautious about new construction. Add up burgeoning demand and tight supply, and many cities could see double-digit rent growth this year, Thorpe says.
Not everyone is so bullish about rental rates. Jed Reagan, senior analyst at Green Street Advisors, a commercial real estate research firm based in Newport Beach, California, expects rent growth to hover in the low- to mid-single digits in 2016.
“Tenants have been targeting greater space efficiencies in this cycle and fitting more employees into less space,” Reagan says. “Technological advances have contributed to this trend, especially for a traditional office-using tenant like a law firm that no longer needs large amounts of space for legal libraries.”
Alexandria’s Moglia agrees that today’s tenants cram more people into smaller areas. In the commercial real estate industry, it used to be conventional wisdom that the typical U.S. company needed 250 square feet of space for each worker. With private offices and cubicles being replaced by open layouts, that number has shrunk to just 150 square feet, Moglia says.
Telecommuting is another trend that could undermine demand for office space. But Moglia points to Sunnyvale, California–based Yahoo as an example of a tech employer that has stepped back from the practice. “It’s kind of going the other way,” he says. “We’ve learned people are more productive when they’re collaborating.”