Office Recovery Accelerates In First Half

U.S. office occupancy growth and rental rates rose at a modest but steady pace during the second quarter of this year, while the national vacancy rate dipped closer to the 12% mark as new office construction remained at historically low levels in the first half of 2013.

“The office market recovery is accelerating. Although it feels like we’re just going from 20 to 25 mph, it is headed in the right direction,” noted Hans Nordby, managing director, who presented CoStar’s State of the U.S. Office Market Mid-Year 2013 Review and Forecast, along with Director of Office Research Walter Page and Manager of U.S. Market Research Aaron Jodka.

The office review and outlook marks the launch of the latest round of CoStar market presentations over the next few weeks that will include the industrial market (Tues., July 30), Retail (Thurs., Aug. 8) and multifamily (Thurs., Aug. 15). Editor’s Note: CoStar subscribers may sign up for the presentations by logging in and clicking on the Knowledge Center tab in the upper right corner.

Through June 30, 2013, net absorption of office space across the U.S. rose 25% over the same period last year, to 25 million square feet. CoStar’s analysts noted that office absorption is still being tempered by the overhang of tenant shadow space left over from the recession, and by the trend toward open but higher density workspaces, with many new leases averaging less square footage per employee.

Nevertheless, the U.S. office vacancy rate continued to decline, dipping from 12.7% at mid-year 2012 to 12.1% as of June 30, 2013, moving steadily toward the 10.5% – 11% vacancy range that analysts would expect in a balanced office market.

While rent growth has begun to ramp up, average office rents increased by 2% in the first six months of the year, compared with 1.7% in the first six months of last year.

However, the headline number doesn’t tell the whole rent growth story, CoStar’s Page said.

“We’re seeing an increasing reduction in [landlord] concessions for free rent across many markets – especially those that offered the most free rent, such as Atlanta,” he said.

One wild card for the office market is the recent uptick in 10-Year Treasurys after years of historically low interest rates propped up by the Federal Reserve’s quantitative easing programs. While CoStar and PPR economists have been forecasting for months that quantitative easing will eventually end, the big story of the past 60 days in the capital markets has been the 70-basis-point rise in the 10-year rate.

While the obvious question is how capitalization rates will react to the rise in interest rates, spreads between marketplace cap rates and Treasurys are fairly wide versus what would be expected at this point in the recovery cycle, Nordby said.

“The good news is that cap rates didn’t follow interest rates all the way down on a one-for-one basis, and they don’t have to go one for one on the way up,” he said.

Moreover, corporate profits remain high, enhancing the ability of companies to hire workers and lease space. Office-using employment growth continues to outperform the broader job market.

Big gains were seen in secondary metro areas in the South and West, such as Jacksonville, FL, Salt Lake City, Nashville, Austin and Denver, where office employment is growing very quickly, bolstered by growth in general back office operations and migration and expansion of companies to markets with lower business costs.

Even Atlanta, which was devastated by the recession and a lackluster performer in the early stages of recovery, now ranks among the nation’s job growth leaders. Interestingly, Atlanta’s growth in tech sector jobs is now above the national average after many years of falling below the U.S. average.

Source: Costar