Limited Construction Is Behind Office Recovery

Marcus & Millichap is based in Los Angeles.

LOS ANGELES—Limited office construction is helping to fuel recovery in the office market, according to Marcus & Millichap executives on a recent office and industrial webcast roundtable . With high demand and no new construction, office market vacancies have been pushed down allowing for rental growth and recovery from the downturn. “A keystone in the market has been limited construction. Completions are still only at about two-thirds of where they were prior to the recession,” John Chang , FVP of research at Marcus & Millichap, said at the roundtable. “Looking at 2015 and the last two years, they have been half or even lower than historical completion levels. That has given this sector a great opportunity to recover from the weakening in the recession and drive vacancy rates back down. At this point, we are seeing vacancies at 14.5% and that is really starting to help support rent growth. We are seeing this momentum build as we tighten those vacancies.” According to Chang and his fellow speakers William E. Hughes , SVP, and Alan L. Pontius , SVP, rent growth in 2014 was 3.5% for the year, and last year, rent growth was 4.5% for the office market. Pontius, however, says that while vacancy rates are coming down, they are coming down slower than expected. Not surprisingly, absorption has also been slow, which Pontius attributes to density in office design and open floor plan or creative concepts. Still, the speakers maintained that the overall office story is a positive one. “Construction is limited and demand is growing, and that is favorable for our office properties,” added Chang. The backlog of maturing CMBS debt due this year will also have a potentially positive impact for the office sector and the economy. “We have a big bulk of CMBS product that is maturing in 2016 that was originated in 2006,” said Hughes. “It is a substantial amount of product, and whenever there is maturity, the investor has to make a decision to go into the marketplace and trade or if they are simply going to refinance it. That is really going to enhance the activity in the marketplace.” Chang went on to say that the growth and transaction volume isn’t exclusive to the primary markets anymore, but is now spreading out to the tertiary markets. “The growth cycle has extended to the point where job growth is reaching to the secondary and tertiary markets, and that is bolstering the growth of assets in those markets,” he explained. “It has really come to the point with those markets are strengthening and those asset values are freeing up, and those investors in the secondary and tertiary markets are putting those properties back up on the market and they are turning in this cycle as well. We are seeing a spread of the transactions. Certainly primary and secondary markets are doing well, but we are also seeing influx and growth in the tertiary markets, which is boosting up the numbers on top of what we would normally see.”