24 New Buildings Push Office Vacancies to 20.6%

A construction slowdown is already under way. From 7.3 million sf of new product in 2001, 24 buildings totaling 2.7 million sf were completed in 2002, the lowest level of deliveries since 1995. Still, at the beginning of first quarter 2003, 3.1 million sf of new space was under construction in metro Atlanta's 155 million-sf, 1,750-building office market.

The amount of new product in 2002 brought overall vacancies to 20.6%, up from 18.6% at this time last year. North Fulton County, one of Atlanta's strongest submarkets, had the highest vacancy rate at 27.5%. Downtown had the lowest level at 15.5%, up from 13% at yearend 2001.

"Atlanta's office market continued to weaken in 2002," says Michael A. Crawford, research director at Bullock Mannelly Partners. "With many companies struggling to turn profits, excess office space has been shed at a hurried pace." Final Labor Department figures for 2002 are expected to show 60,000 non-agricultural jobs were lost in metro Atlanta due to office staff reductions.

However, "with a little luck, 2003 will provide a respite, or year of repair, as the construction pipeline has slowed and absorption has taken a beating," Crawford says. "Atlanta's long-term investment potential remains promising, however, due to its central southeastern location, diversified employment base and low cost of living."

But the researcher acknowledges "the amount of space that is currently available, as well as the uncertainty of the economy, has made many lenders hesitant to look at the office sector."

Crawford says lenders "will remain cautious of these transactions until the economy begins to improve by adding jobs and absorbing space." He says deals that already have closed are "typically on a low leverage basis, providing the lender with additional security." But smaller properties, as well as medical office buildings, "may gain favor among investors scouting stable or value-added opportunities."

Through third-quarter 2002, Bullock Mannelly Partners tracked 96 transactions valued at a total $513.8 million. "Yearend results will likely show a sales volume decrease of more than 20% over 2001," Crawford projects.

Despite the slowdown, the average price per sf has remained stable at about $128 per sf. With only two high-rise properties selling year-to-date, Three Ravinia and the Lenox Building, the average price per sf was $155. Mid-rise buildings were close behind with an average $147 per sf. Low-rise properties averaged $96 per sf.

It's a tenants' market in Atlanta, as it is in most major metro areas, with 32.2 million sf of office product available. About 6.44 million sf, or 20% of that total, is subleased space. Class A space accounts for 50% of the total 32.2 million-sf inventory; class B, 45%; and class C, 5%. Net absorption in all three categories was a negative 1.8 million sf in 2002, one of the softest postings in years.

"It will likely take several months before conditions improve," says Crawford. Negative absorption numbers were recorded in half of Atlanta's submarkets, including Downtown, Northlake, Buckhead, Northwest and Central Perimeter. Although North Fulton, Northeast, South, Midtown and West submarkets showed positive absorption, "it was lackluster, at best, resulting in less than one million sf combined," says the researcher.

Of the new construction under way, the Central Perimeter, Midtown and North Fulton submarkets are the most active. "With an explosion of residential and niche retail development in recent years, the Midtown submarket continues to expand" with the Atlanta Station, 17th Street and Centergy at Technology Square developments, Crawford says.

The $2 billion Atlantic Station project has two four-story, 128,000-sf office buildings under construction. "Although several [new] projects have been proposed [for metro Atlanta], far fewer properties have been started in 2003," he says.

The abundance of available space has caused rents to dip. The overall average rent in 4Q 2002 was $19.71 per sf. After slipping to $22.24 per sf in 2Q, class A quoted rents continued to decline to $21.81 per sf. Class B rents dropped to $16.89 per sf; class C, $15.30 per sf. The highest rents are in the Buckhead submarket at $24.12 per sf. The lowest average is in the South Atlanta submarket, $15.75 per sf.

To attract new tenants and keep existing ones, property owners are offering larger tenant improvement allowances, moving costs and free rent, from a few months to two years, depending on the length of the lease.

"Significant challenges remain for the Atlanta office market in 2003," Crawford concludes. "With vacancy rates trending upward, property owners will continue to concentrate their efforts on improving NOIs (net operating income) during the next several months."

On the investment sales side, "although many investors remain bullish on the Atlanta market, office sales will likely remain subdued in 2003," the researcher says.