New Construction Driving Up Vacancies

New construction is driving the vacancies to higher levels, a new CB Richard Ellis first-quarter study, to be released Friday, will show.

"Low office vacancies overall indicate a little wiggle room for the office market to absorb a slight economic slowdown," Clutter says. There is expected to be a temporary blip in occupancy because 8.7% of the overall office market or 2.5 million sf is under construction as of the beginning of the year.

"The construction market is expected to deliver the new space, 69% pre-leased as of the first of the year, over the next 24 months," the report says. The new space will push up occupancies, at least initially.

One characteristic of last year's market was the user-buyer relationship. Says Clutter: "One of the most interesting things that happened was that users dominated the sales side for office. Users dominated the sale side for industrial. Users even dominated the buy side for industrial."

Those factors have kept rents down, "but as the market improves, rents will start to rise again and cap rates will start to come down."

Today's buyer's market will build until equilibrium is reached by the end of the year when the market will be much friendlier to sellers, he predicts. "In the interim, attractive financing interest rate cuts will make refinancing a strong option for investors of all capital segments," the report predicts.

One striking aspect of the report shows Downtown vacancies at only 2.17%.

Perhaps not unexpectedly, the suburban market saw the largest amount of new office space. But the report says the suburban market offers good opportunities for long-term investors looking beyond the temporary slowdown in rent growths caused by new construction and the slowing economy.

In certain specific sub-markets, such as Southpark, the rebound should be even quicker, according to Clutter. The current slowdown is particularly affecting technology-specific office parks. More available space is coming back to the market because of corporate foreclosures and an increase in sublease inventories, the report says.

Another trend in the area, attributed both to market uncertainties and lower costs, is a growing demand for flex space. Flex market vacancies have tightened considerably to 11.9% versus 15.1% only a year ago, according to a separate report by Karnes Research Co. The Ellis report also found the cooling market has led institutions to often shift capital away from office properties into multifamily and industrial projects.