Office Pipeline Fills Up Across US

LOS ANGELES—That apartment construction is going through a boom period is not news. And CBRE reported last week that the development pipeline for industrial is quite full at 140 million square feet. Office development, by contrast, has been limited to a handful of markets since the downturn: notably Houston, where more than 18 million square feet are in the works; and Manhattan, which the New York Post reported Tuesday will see at least 9.5 million square feet of new, as-yet unleased space hit the market by 2018—and even more if a proposed office tower near Grand Central Terminal comes off the drawing board.

That status quo appears to be changing. In its outlook report for the office sector for 2015, Kroll Bond Rating Agency reported recently that the amount of rentable building area is now the highest since just before the capital markets crisis of 2008. “Higher demand and improving fundamentals have contributed to an increase in construction activity,” according to KBRA.

In its Annual Strategy Outlook report, Principal Global Investors reports that office is “at the beginning of a new construction cycle, but not necessarily one that will result in excessive supply. The dearth of capital during the depths of the last recession coupled with the precipitous declines in both prices and office rents has kept the construction pipeline largely dormant.” However, says Des Moines-based Principal, “the capital spigot for office construction is beginning to reopen” as rents and pricing recover.

There are limits on how far that spigot will open, of course. Principal's report notes that non-recourse construction financing remains unavailable, while “some banks are unwilling to finance speculative office construction at all, even with recourse provisions and meaningful equity.” Even so, several markets have begun to see pipelines come to life, and the firm says this year will see “the most significant additions to office stock of this cycle to date. While completions rates nationally remain well below historical trend, a few markets are expected to see supply equal or exceed historical trend in over the next two years.”

Exactly how much space is under construction depends in part on the source. KBRA puts the tally at 73.8 million square feet across its KPrime markets at the end of the fourth quarter of 2014. CBRE puts a higher number on it: 88.7 million square feet under construction at year's end, up from 83.6 million at the end of Q3, with 20 of the markets CBRE tracks reporting activity at 2% or more of standing inventory.

A particularly notable trend is a revival of multi-tenant construction. CBRE says that in Q4, 8.8 million square feet of such space came on line, nearly 60% more than the 5.5 million square feet of new multi-tenant supply added in Q3 and a 7.8% year-over-year increase. The firm says Q3's total was more evenly split between downtown and suburban markets, with 3.8 million square feet delivered in CBDs and 5.0 million square feet completed in the suburbs.

Although annual multi-tenant completions reached their highest level since 2010 last year, “the total of 22.3 million square feet remains less than half the historical average,” according to CBRE. “However, the concentration of multi-tenant deliveries in only a few markets indicates that the strongest metros have fully recovered to a standard supply cycle.” Five markets—Houston, New York City, Dallas/Fort Worth, Washington, DC and San Francisco—each saw more than one million square feet of multi-tenant office space delivered in 2014. That being said, CBRE notes that Q4's increase in overall office development was driven entirely by single-tenant construction.

Even so, CBRE says, “Construction activity has broadened across markets as it has risen, keeping construction's share of existing office market inventory relatively manageable in most markets.” As a case in point, DTZ's Q4 Office Trends Report puts the tally of space under construction at 103.8 million square feet across the 80 markets it tracks. Of those 80 markets, just 13 had no space in the pipeline as the quarter ended.