Improvement for Office, But Forecast Remains Slow Growth

The widely publicized internal memorandum from Yahoo CEO Marissa Mayer, putting a ban on telecommuting by employees, has encouraged leasing experts who see it as a corrective to the perception that office footprints are shrinking. “It has tremendous implications if one of the titans of the Internet says, 'we want to collaborate inside,'” William Glazer, president and CEO of Keystone Property Trust, said at RealShare Philadelphia in early March. At the same conference, Ray Milora, project executive on GlaxoSmithKline's relocation to the redeveloped Philadelphia Navy Yard, said his firm had received scores of requests from telecommuting GSK employees who wanted to be part of just such an on-site collaboration.

But the work-from-home debate, with its implications for office property owners and developers, isn't going away anytime soon. “Workplace strategy is a vitally important aspect of corporate organizations, because it directly influences outcomes with branding, human resources management, real estate, sustainability, site selection and risk management,” said Richard Kadzis, vice president at CoreNet Global in Atlanta, earlier this month.  “It is not a one-size-fits-all proposition.” The organization recommends that its members work with their companies' HR departments to go beyond traditional metrics for productivity, such as cost per square foot or revenue per employee.

A CBRE report, “13 Trends for 2013,” predicts that this year we'll see a move toward increased space efficiency thanks to technology's impact on workforce flexibility. However, the report doesn't chart a steep decline in the average amount of office space per employee, either this year or next. Between 2013 and 2014, it will dip slightly while still remaining above 210 square feet per employee, well above the 1999 trough of about 196 square feet per worker.

Nonetheless, the debate is occurring in the context of a slowly recovering office sector, with the rate of recovery varying widely by market.  Nationally, “the good news is that absorption has been positive, but slightly less positive” in 2012 than in 2011, said Maria Sicola, head of US research for Cushman & Wakefield, during a C&W webinar in mid-January. Although rent growth overall has been flat when both CBD and suburban markets are factored in, conversely rents have not been declining, she said. C&W cited New York's Midtown South, Boston and San Francisco as markets that have been seeing strong rent growth; the outlook for all three is positive as the current year progresses. 

“The reasons for the weak office sector recovery are not hard to find; chief among them is the disappointing rate of job creation,” according to an article prepared by Reis Inc. and Newmark Grubb Knight Frank for Deloitte's “Expectations & Market Realities in Real Estate 2013” report. Overall, the US labor market has recovered about half of the 8.8 million jobs lost to the Great Recession, according to Reis and NGKF. “Office-using jobs—information, professional and business services and finance—have done slightly better, recovering about three-quarters of the lost jobs, but the rate of growth has not been enough to fill the space that was emptied due to layoffs and downsizings.”

The result: about 100 million square feet of shadow space—“leased but unoccupied”—remains on the market, according to Reis and NGKF. “As the underlying leases gradually reach their term, most of the space is returned to the pool of direct vacant space, which keeps the vacancy rate from falling as fast as it would in a normal recovery.”

Coupled with lackluster job growth has been equally sluggish GDP growth. In the past five recessions prior to the most recent one, GDP recovery three years out has averaged 15%. This time around, it was half that figure. “This recovery, which began in 2009, has been by just about any measure the slowest on record,” said Kenneth McCarthy, regional research director at C&W, during January's webinar.

Accordingly, “risk-taking behavior” will be low across the US among office-using employers. Two sectors that are exceptions to this rule are technology and energy, and Sicola noted that rent growth and leasing activity have been brisk in cities where these tenants have a strong presence, with San Francisco a notable case in point.

Given sluggish improvement in both job growth and GDP, Reis and NGKF suggest that the sector won't finish 2013 in a much different state than it was at the end of 2012. It appears that the vacancy rate will decline around 1.2 percentage points, ending the year at 16%,” according to Reis and NGKF. “This is still above the equilibrium vacancy rate of 13% to 14%, where landlords and tenants have roughly equal bargaining power and the average asking rent, theoretically, rises at the rate of inflation.”