Office Supply Dearth Should Prevent Vacancy Spike

OAKLAND, CA—For obvious reasons, Oakland is showing up on analysts' buy radar. According to Ten-X Commercial's latest US office market outlook, it is one of the top five buy markets for office properties. The analysis shows a sector that has continued its agonizingly slow recovery into 2017, but faces the prospect of increasing cyclical risks associated with slower employment growth.

The report pinpoints Oakland, Portland, Sacramento, Dallas and Atlanta as the five US cities showing the greatest promise for investors of office properties. Concentrated largely in the West, these markets are boosted by growing populations and strong employment, keeping rents high even as supply additions loom on the horizon.

Employment levels in Oakland are at an all-time peak, highlighted by a 2 to 3% increase in the professional/business services sector. While local employment and population are both on the rise, a cooldown in regional tech growth may incur some downside risk for the area. First-quarter negative absorption pushed vacancies to 14%, but that figure is 70 basis points lower than a year prior. A year of robust growth has elevated effective rents to an all-time high. Even under the Ten-X downturn scenario for 2019 to 2020, a general absence of incoming supply is expected to prevent Oakland from suffering a dramatic rise in vacancies.

“The outlook for Oakland office fundamentals is buoyed by a relatively quiet development pipeline that is limiting new supply and a healthy local economy that is helping to generate demand,” Peter Muoio, chief economist of Ten-X, tells GlobeSt.com. “Over the past year, the professional/business services, education and healthcare sectors have created jobs and pushed up payroll levels, bringing the area's employment level to an all-time peak. To be sure, a downturn in the tech sector would hurt Oakland like it would the San Francisco and San Jose markets. But with effective rents at an all-time high and projected to climb, NOI contraction should be minimal in the event of a cyclical downturn, making this a relatively defensive play.”

The report specifically highlights slowing employment gains across much of the country. Limited job creation–a dynamic occurring in a labor market approaching full employment–is likely to suppress the need for companies to add to or expand office space requirements, slowing absorption.

The Ten-X analysis notes that vacancies remained flat to start the year and have subsequently hit the midyear point with no improvement yet this year and at 16%, flat with a year ago. Vacancies remain at a level far higher than during the prior expansion. Stalled vacancies have resulted in lower rent growth, with rents advancing at the slowest pace since 2012. Ten-X expects vacancies to reach a cyclical trough of 15.3% in 2018, however the firm's downside recessionary model foresees vacancy levels reaching 17.6% by the end of 2020, which would be on par with the recessionary peaks of 2010.

“While we're seeing tepid growth nationally, office investors have to be aware of cyclical risks associated with subdued job growth. It is noteworthy that our analysis resulted in downgrades in 17 regions and an upgrade to only one,” said  Muoio. “That said, a number of economically vibrant metro areas around America are seeing high levels of absorption and present buyers with strong investment opportunities.”

While office rent growth has slowed in recent quarters, Ten-X expects growth to reach the mid-2% range on an annual basis in 2018. The company's downside recessionary model expects office rents to contract by less than 1% by 2019 and by less than 1.7% by 2020 as vacancies reach recessionary levels.

The Ten-X analysis also identifies Memphis, Baltimore, Houston, Fort Worth and Suburban Maryland as areas where investors may wish to consider selling office assets. While the respective employment climates in these markets vary considerably, each is seeing rents decline as new supply meets with slow or even negative absorption rates.

OAKLAND, CA—For obvious reasons, Oakland is showing up on analysts' buy radar. According to Ten-X Commercial's latest US office market outlook, it is one of the top five buy markets for office properties. The analysis shows a sector that has continued its agonizingly slow recovery into 2017, but faces the prospect of increasing cyclical risks associated with slower employment growth.

The report pinpoints Oakland, Portland, Sacramento, Dallas and Atlanta as the five US cities showing the greatest promise for investors of office properties. Concentrated largely in the West, these markets are boosted by growing populations and strong employment, keeping rents high even as supply additions loom on the horizon.

Employment levels in Oakland are at an all-time peak, highlighted by a 2 to 3% increase in the professional/business services sector. While local employment and population are both on the rise, a cooldown in regional tech growth may incur some downside risk for the area. First-quarter negative absorption pushed vacancies to 14%, but that figure is 70 basis points lower than a year prior. A year of robust growth has elevated effective rents to an all-time high. Even under the Ten-X downturn scenario for 2019 to 2020, a general absence of incoming supply is expected to prevent Oakland from suffering a dramatic rise in vacancies.

“The outlook for Oakland office fundamentals is buoyed by a relatively quiet development pipeline that is limiting new supply and a healthy local economy that is helping to generate demand,” Peter Muoio, chief economist of Ten-X, tells GlobeSt.com. “Over the past year, the professional/business services, education and healthcare sectors have created jobs and pushed up payroll levels, bringing the area's employment level to an all-time peak. To be sure, a downturn in the tech sector would hurt Oakland like it would the San Francisco and San Jose markets. But with effective rents at an all-time high and projected to climb, NOI contraction should be minimal in the event of a cyclical downturn, making this a relatively defensive play.”

The report specifically highlights slowing employment gains across much of the country. Limited job creation–a dynamic occurring in a labor market approaching full employment–is likely to suppress the need for companies to add to or expand office space requirements, slowing absorption.

The Ten-X analysis notes that vacancies remained flat to start the year and have subsequently hit the midyear point with no improvement yet this year and at 16%, flat with a year ago. Vacancies remain at a level far higher than during the prior expansion. Stalled vacancies have resulted in lower rent growth, with rents advancing at the slowest pace since 2012. Ten-X expects vacancies to reach a cyclical trough of 15.3% in 2018, however the firm's downside recessionary model foresees vacancy levels reaching 17.6% by the end of 2020, which would be on par with the recessionary peaks of 2010.

“While we're seeing tepid growth nationally, office investors have to be aware of cyclical risks associated with subdued job growth. It is noteworthy that our analysis resulted in downgrades in 17 regions and an upgrade to only one,” said  Muoio. “That said, a number of economically vibrant metro areas around America are seeing high levels of absorption and present buyers with strong investment opportunities.”

While office rent growth has slowed in recent quarters, Ten-X expects growth to reach the mid-2% range on an annual basis in 2018. The company's downside recessionary model expects office rents to contract by less than 1% by 2019 and by less than 1.7% by 2020 as vacancies reach recessionary levels.

The Ten-X analysis also identifies Memphis, Baltimore, Houston, Fort Worth and Suburban Maryland as areas where investors may wish to consider selling office assets. While the respective employment climates in these markets vary considerably, each is seeing rents decline as new supply meets with slow or even negative absorption rates.