Part 1 of 2

Across the country, the economic expansion is entering its eighth year overall. Those thoughts are according to David Antonelli, EVP, and Michael Keating, SVP of portfolio management at Bentall Kennedy. The duo talk about all things office, including what is happening in the suburban office market, and what today's tenants are looking for in the exclusive Q&A below.

GlobeSt.com: Latest numbers show that the national office market seems to be perfectly balanced, with 40 million square feet of new development and approximately 41 million square feet of net absorption over 12 months. And rents are going up in some markets. Why do you see this as a tenant-favorable market?

Michael Keating: While the market figures balance out on a national basis, a closer look reveals that some markets are doing much better than others, mostly due to choices companies are making about where to create jobs. This bifurcation is very much a reflection of the broader economy; the gateway primary markets and select secondary markets with strong innovation economies are doing well, while many other secondary and tertiary markets continue their efforts to recover from the global financial crisis.

Across the country, the economic expansion is entering its eighth year overall. The pace of job growth, however, has been uneven, concentrated in a handful of cities. The office markets reflect those job growth figures. In fact, the top 11 US markets have done really well for the most part, while tenant-favorable conditions still exist in certain smaller markets.

GlobeSt.com: With job growth of 2.2 million nationally over the past year—driven in part by an increase in knowledge workers—should the office market be in better shape than it is?

David Antonelli: Knowledge workers are growing in number—but not necessarily in how much space they need to do their jobs. Given the slow but steady pace of economic growth in recent years, office vacancies are about where we would expect to see them. The national office vacancy rate is hovering around 13% as of Q2 2017, which is just below the 10-year average.

Historically, the market for office space has been highly correlated to economic growth and job growth in particular. More jobs meant more demand for office space. While the connection between jobs and space hasn't gone away, it's not as direct as it once was. Corporations are fundamentally shifting how they use office space, in ways that collectively reduce overall demand per person. Therefore, more jobs do drive more demand—but significantly less demand than they once did.

This dampened demand is emerging because more employees are working in more locations, and less at a single desk. To facilitate creating flexible work options, we see progressive companies increasingly embracing non-traditional office arrangements and choosing more efficient workplace designs. The result is a dramatic reduction in the average space needed per employee. Space allocation per person can vary widely from one company to the next, but on average, companies need about half as much square footage per employee today as they did 20 years ago. And that means overall economic growth doesn't mean as much growth in office markets as it once did.

GlobeSt.com: In Bentall Kennedy's Perspectives report for mid-year 2017, you pointed to recent strong activity in suburban office markets. Is this trend continuing?

Keating: Suburban markets are sending mixed messages. There happened to be a lot of absorption of suburban office space in the first quarter of 2017. In contrast overall, we see suburban office markets underperforming urban markets. Tenants continue to pursue the most desirable workers, who generally prefer live/work/play communities in cities. Large companies like GE, Amazon and Uber are all focusing their expansion or relocation plans in urban spaces. We expect that job growth will continue to be centered around urban innovation hubs as well.

That said, some firms are starting to look beyond these desirable urban locations for talent, and as a result, adding suburban offices in addition to expanding their presence in 24-hour city locations. In some cases, this is because urban rents are so high. Additionally, there are still places like Silicon Valley where a campus environment is coveted by the top talent in certain industries, particularly technology and life sciences.

Toyota's campus in Plano, Texas and Nike's campus in Beaverton, Oregon are prime examples of “place making,” where companies create an environment to offer the same range of amenities that employees would have access to in an urban location. But these are the exceptions, not the rule.

GlobeSt.com: If a recession should occur, are office investors likely to suffer in an economic downturn?

Antonelli: Even though we're in a late stage of the economy cycle, the timing of the next recession is impossible to accurately predict. Sooner or later there will be a recession, and it will absolutely impact demand for office space—and some markets will fare better than others, largely depending on how successful a market has been at delivering an overall positive community experience for the people who work there.

During the global financial crisis, high-barrier-to-entry markets like San Francisco and New York recovered more quickly and more fully than other major markets like Atlanta and Chicago where the geography and zoning practices allow greater supply imbalances. And the majority of economic growth since the recession has been centered on these high-barrier-to-entry markets. That's especially true when it comes to job growth in knowledge industries.

There are steps investors can take now to prepare for a downturn. We're strategically positioning our portfolio to be as economically resilient as possible. Concentrating on central business districts in key gateway markets is the first part of that strategy. The second is that we're managing our rent roll by working with tenants on early renewals, so we're not facing a high concentration of lease maturities in the event of a downturn.

One other step we're taking to mitigate late-cycle risk is increasing our investments in medical office buildings. For instance, in the third quarter we acquired a medical office building with a long-term lease in Portland. With an aging population, our nation's demand for healthcare will not subside any time soon, so it's a very economically resilient office investment. Also, in some cases, we are using debt and debt-like structures to further de-risk additional investments in office.

Check back in the next day or so where the duo looks deeper into what amenities are most effective for attracting tenants and what investors can do to increase a building's desirability and enhance ROI.

Part 1 of 2

GlobeSt.com: With job growth of 2.2 million nationally over the past year—driven in part by an increase in knowledge workers—should the office market be in better shape than it is?

GlobeSt.com: In Bentall Kennedy's Perspectives report for mid-year 2017, you pointed to recent strong activity in suburban office markets. Is this trend continuing?

GlobeSt.com: If a recession should occur, are office investors likely to suffer in an economic downturn?

Instant Insights /

Happy Tenants Make a Healthy Office Market

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