Rent Declines May Hold Surprising News

The new report aims to put the rent declines into historic perspective as the financial crisis deepens and job losses continue for the second year running. Considering that office vacancy rates increased by 1.4% in 2008 and vacancies are expected to increase as the downturn continues, the report foresees that rents "are all set to fall in the coming years."

The study points out that long-term real rents, adjusted for inflation, suggest that in many markets office rents bottomed out only as recently as the end of 2004 and, although they climbed considerably after bottoming out, real office rents in the cycle leading up to this recession never did reach their previous peak, which was set in 2000. Compared with the rise in rents in the late 1990s, the rent increases of this cycle "were well-contained," according to the Torto Wheaton report.

As examples that illustrate this historic trend, the report examines the office markets in New York and San Francisco. "Despite 2008's being Wall Street's worst year since 1931, New York's office market continued to benefit from low vacancy rates, and rents only started to moderate in the second half of last year," the report points out. The record job losses and negative absorption suggest that in New York "rents need to be corrected" in the next few years, "especially considering that they stand at 116% of the market's historical average," the report says.

In San Francisco, on the other hand, rents now stand at 94% of their historical average after falling sharply following the dot-com collapse of 2000. So far, thanks to its dependence on non-financial service and technology companies, the San Francisco market has been spared the magnitude of job losses and negative absorption that New York has suffered, Torto Wheaton points out.

The far-reaching effects of the recession will nonetheless spread to these non-financial office tenants, which will mean that vacancy rates and rents in San Francisco "will adjust accordingly." But the rents in San Francisco are expected to fall only at an annualized rate of 3.4% for the next four years, compared to New York's 7.4%. "In other words, although rents are expected to fall in most markets in the years ahead, you can generally expect markets with more inflated current rent levels to see sharper rates of rent decline," the Torto Wheaton report concludes.