Investors Have Cause to Celebrate Gains in 2013 as Office
Recovery Hits Only the Halfway Point
Investors are cheering the gains in asset values seen during
2013 from a strengthening recovery in the U.S. office market, and looking
forward to an even brighter 2014 as virtually all the important metrics that
drive rent growth and property income are expected to continue to improve over
the next 12 months.
The robust office market performance was the highlight of
the year-in-review analysis and forecast webinar presented by CoStar market
experts Walter Page, director of office research; Hans Nordby, managing
director and corporate officer, and Aaron Jodka, manager, U.S. market research.
According to CoStar's analysis, net absorption in the U.S.
office market rose a solid 22% in 2013 over the previous year to 59 million
square feet, with the increased demand helping push the vacancy rate down 50
basis points from 12.4% to 11.9%.
The growing demand for office space, combined with an
extended period which has seen little to no new office construction, resulted
in the average U.S. office rent to grow 3.1% last year - the first time rents
have cracked the 3% annual growth mark since 2007, the peak of the market
cycle.
New office construction remains muted with just 40 million
square feet of new office space added in 2013, and another 78 million square
feet under construction at the end of December. Any gains in construction were
largely offset by the loss of existing office space as older buildings were
demolished or converted, in many cases to be replaced with apartment or
condominium properties.
Despite a flattening yield curve and expectations that
10-Year Treasurys will rise to nearly 5% over the next few years, investors
increased office purchases by 20% last year, for total office property sales of
$106.2 billion, driven in part by demand created by the 2.4% gain in
office-using employment in 2013, well above the overall U.S. employment growth
rate of 1.6%.
Looking ahead, the CoStar analysts expect the country should
finally reach its pre-recession employment peak by summer 2014, building on the
750,000 new office-using jobs gained in 2013.
The office recovery continues to evolve and broaden in new
and different directions. While CBD markets in top-tier gateway markets saw the
lion's share of improvement earlier in the recovery, suburban office is now
recovering at a dramatic rate, driven by gains in technology, health care,
education and even energy industry jobs.
"Markets such as Charlotte are being driven by
diversifying economies and lower business costs. Many of the jobs coming into
the office sector such as call centers don’t use CBD towers, but they do absorb
space," Nordby said. "This is one of the few calls we've been on
where it's hard to find much bad news at all."
Vacancies Down, Rents Up
In fact, the CoStar analysts said, 2013 was a great year for
the office market. Even better, the office recovery is only at about the
halfway point -- the vacancy rate is expected to plummet another 100 bps to
10.9% by the end of 2015, noted Page, adding that the 59 million square feet of
net absorption included a strong year-ending 20 million square feet in the
fourth quarter.
"For office investors in particular, the second half of
this recovery is what they like," Page said. "With the occupancy
gains, we should see rent, NOI and value gains.
"We are reaching what I’d call a sweet spot -- and
we’re also reaching a tipping point, the 11.6% vacancy line which is the
historical average between 2004 and 2012," Page added. "At that
point, we will really see accelerating rents."
Roughly half of major markets have already reached or are
near that point, including Pittsburgh (8.2%) New York City (8.8%), San
Francisco (9.3%) and even St. Louis (11.6%). Baltimore (11.6%) and Philadelphia
(11.7%).
Not reflected in the hard numbers is the decline in free
rent and concessions offered by landlords, which have been cut in half in such
markets like Seattle, Boston and Miami. Rent discounts tenant improvement
packages are also shrinking in many markets, Page said.
While the majority of U.S. office markets experienced
notable gains, others still have a ways to go. Detroit and Phoenix still have
vacancy rates of 17.9% and 18.2%, respectively, but they’ve also come down from
stratospheric levels.
The Amazing Suburban Office Rebound
While suburban office markets were still largely lackluster
as recently as a year or two ago, CoStar analysts now describe the recovery in
the suburban office sector using superlatives such as amazing, remarkable and
"on fire."
Lingering higher vacancies have prevented additional
construction in many suburbs, which are also benefitting from the fast-growing
tech, health-care and other employment sectors. Suburban markets, which make up
a much higher share of total office inventory than CBD markets, account for 90%
of total office absorption.
"Some of the recovering suburban markets would have
been in tough shape a year, 18 months ago," Nordby said. "The economy
has become much more broad-based, and normal, low-cost back-office places like
Tampa and Phoenix have been posting very good job growth."
Cranes Rising In More Markets
While office construction starts remain low as a percentage
of existing inventories, building has been relatively brisk in a few markets
like San Jose, Austin, Houston and Boston -- and more recently, San Francisco,
Dallas, Northern New Jersey and even Chicago.
Most projects are built with tenants or owners in tow,
although developers are beginning to move forward on a handful of speculative
projects. It's hardly a surprise to see cranes piercing the skyline in San
Francisco, where 2.5 million square feet is under construction, including Jay
Paul Co.'s 181 Fremont, a $500 million mixed-use tower in the South Financial
District with 415,000 square feet of speculative office space.
San Francisco CBD rents have risen 63% from their recession
lows, compared with average 5.7% rent growth for the 54 largest markets.
"Much of this activity is smart money getting under way
before the cycle becomes long in the tooth, and we’ll see more of this across
the country," Nordby said.
Source: Costar.com
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