What it Takes to Be a Top Office Market

GlobeSt.com: What do the top office markets in your report have in common?

Muoio: The first, and most important, answer is, “Follow the jobs.” All the areas that are generating office growth are also generating strong job growth. Second, four of the five markets at the top are clearly identifiable as markets where some form of technology is a key driver of the office economy. So, follow the jobs, and follow the technology. Third, several of the top markets—New York, San Francisco, San Jose, Seattle—are strongly supply-constrained markets. They're not the kinds of markets that are easy to flood with space, even though development is taking place. These markets have had and continue to have demand because of job growth, particularly because of the tech sector.

GlobeSt.com: Can a market perpetually remain on top, in your opinion?

Muoio: No. I would be shocked if that were the case. You hear rumblings and people commenting that technology is frothy, about booms and busts and corrections. You could easily envision if you have a hiccup in the tech markets, they'd no longer be at the top because that would affect their job growth. In the bottom-half markets, one is Houston. Two years ago, Houston could have been one of the high markets, with oil generating a lot of jobs. Fast forward, and oil crashes, job production turns south, and now it's in the bottom five.

GlobeSt.com: What else makes a market head for the bottom five?

Muoio: There's typically a classic mismatch of demand falling off exactly when supply is coming online. In Houston, the vacancy rate jumped up 50 basis points quarter-over-quarter, and year-over-year it went up a full 120 basis points. It went from a peak absorption rate of over 1.4 msf at the end of 2014 to a little over 50,000 square feet in the most recent quarter and will probably go negative down the road. But the supply that started two to three years ago will be coming inexorably on, and you'll have a supply/demand mismatch. Ft. Worth, while less directly dependent on energy, is in a similar situation: there has been strong demand, and as a result of that, development has started to pick up in that market.

In other markets, like Cincinnati and Memphis, where the economy never got growth traction and was not really going anywhere, there's not been a lot of office growth in markets like that, and that's why they're in the bottom five. Pittsburgh is a little bit of an oddity; it's like a mini-Houston. There was a lot of activity with shale production in Pennsylvania and Ohio, but it has petered off, and Pittsburgh's economy has gone into the doldrums. There's no demand, and the supply from earlier excitement about the place coming back is now coming online.

GlobeSt.com: What's the smartest way to invest in office properties to hedge against the downturn of a cycle?

Muoio: I am a big believer in diversification. It's the only free lunch. One of the ways to do it is to have a very well-diversified portfolio to ride out the bad times in the other sectors. The other alternative is to identify the key drivers for an office market—for example, if you are an investor who's bullish on tech, you can identify the tech markets and say, “OK, I'm going to do New York, Seattle, Raleigh-Durham and San Francisco.” If you think tech is frothy, but you like the healthcare markets, then you'd invest in Raleigh-Durham, Nashville and Minneapolis. So, you can identify the bets you want to take based on the next driver or the most consistent driver, or you can diversify among those drivers.

Right now, another method I like is looking at post-housing-bust markets—Phoenix and Atlanta and Florida, maybe even Las Vegas. The reason I like those is they're markets where if you look back over the last 20 to 30 years, they've always had strong office development. These markets were historically strong until the housing bust, but now that the housing market is recovering and that weight has been taken away from those markets, we're seeing the overall economies in each of them starting to bloom. They're re-attracting population inflows, and we're now seeing demographic expansion speed up again. That's a nice combination of an accelerating economy, demographics and a still-restrained development pipeline from the hangover of the housing bust. We should see nice recoveries in those post-housing-bust markets because of this over the next several years and the fact that investors have avoided them.

GlobeSt.com: What else should our readers know about your report?

Muoio: In the top end of the report, we talk about the US statistics and second-quarter figures, and it looks like nothing happened: vacancies are flat, absorption was moderate, supply was even and rents grew a little bit. From that, you can get the false impression that nothing's happening. But it really isn't a national office market. It's a very distinct metro office market, and each metro is doing very different things from the supply and demand sides.