Seeing Light at the End of the Tunnel
This is an HTML version of a story that ran in the June issue of Real Estate Forum. To see the article in its original format, click here.
A few months ago, much of the talk surrounding US real estate was about whether the slowly improving markets might finally escape the long recession’s gravitational pull. That hope still exists, but now some worry that sharp budget cuts due to sequestration could foul this tender recovery. The US office market has seen increased activity, but questions remain concerning such issues as the direction of vacancies, values and construction.
“It’s holding up pretty well,” Maria Sicola, executive managing director and Americas research head for Cushman & Wakefield, says of the US office market. “We still have vacancy rates that are pretty low and coming down; but they’re coming down slowly.”
First-quarter research by CBRE found that “the office vacancy rate fell by 10 basis points as the nation’s office markets generally withstood an uneven economic recovery as well as the federal budget sequester. Office vacancy has now declined for 11 consecutive quarters and stands at 15.3%, its lowest level since the first quarter of 2009.”
Sicola agrees that the sequester has not yet had a major impact, except perhaps in Washington, DC, but she points to two other factors that could also limit a recovery. First, job growth was already a bit too slow to fully revive the economy. Second, American businesses continue to search for ways to increase efficiency and shrink their office footprints. These issues “are more important [than sequestration] because they speak to a transformational change in the industry.”
Still, job growth in many cities has not been negligible. For example, MB Real Estate just published its May Market Report, which states: “According to the Bureau of Labor Statistics, Chicago added over 80,000 jobs in 2012, the second-largest yearly gain in employment since before 2003. However, many companies have been right-sizing their leases to accommodate shrinking square-foot-per-employee ratios and space-saving cloud technology.” And since this left many firms with unused space still covered by their leases, even a recovering economy means they can expand without growing their office footprint.
This so-called “shadow space” is “definitely having some impact on absorption,” says Umair Shams, an economist at CBRE Econometric Advisors. In the first quarter, the US office markets absorbed only three million square feet, the weakest rate since 2010 and a big drop from the previous quarter, when they absorbed 23 million, Cassidy Turley researchers found. Vacancy rates remained flat at 15.4% but still about 200 bps higher than pre-crisis levels.
“Fundamentals continue to improve, but the office sector is clearly going through a transformation,” says Kevin Thorpe, chief economist at Cassidy Turley. “Many businesses are reassessing space needs and recognizing they can function perfectly well with a smaller, more efficient footprint. As a result, job growth is not giving the same pop in demand we’ve grown accustomed to.”
Therefore, the low vacancy rates that cities like Chicago experienced in the late 1990s will remain out of reach for some time, MBRE states. “Instead, in the near term, as start-ups mature and established companies finish re-filling their excess space, we expect direct vacancies to continue their slow, methodical decline, despite the strong demand drivers previously discussed.”
Despite these concerns, C&W, using a somewhat different methodology than Cassidy Turley or CBRE, found that the overall vacancy rate in US CBDs fell slightly in the first quarter to 13%, down nine basis points from the end of last year and 44 from last year. Although many gateway cities had lower-than-average rates, they fell at a slower pace or not at all. Some even increased. The vacancy in Midtown South in New York City, for example, sank to only 6.9%, down 0.14% from last quarter. But rates in San Francisco and Portland rose 0.12 and 0.02 points, respectively, to 8.9% and 10.8%.
According to research on gateway cities by CBRE, “leasing trends softened in these markets amid heightened uncertainty surrounding the impact of federal sequestration combined with tepid economic growth through the end of 2012.” CBRE found that “among gateways, Chicago was the only one with a vacancy decline (-10 bps) in Q1.”
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