U.S. Office Tenant Demand Cools in Face of Rising Supply
Real Estate In-Depth | April 5, 2017
CHICAGO—Tenant demand for U.S. office space continued to cool off in the first quarter of 2017. Brokerage firm Cushman & Wakefield reports that overall occupancy levels remained stable, while rents continued to rise in most major markets.
Neighboring Fairfield County, CT had the highest first quarter office vacancy rate in the nation at 23.1%, followed by Northern Virginia at 21.3%, Cushman & Wakefield reports. Westchester County’s overall first quarter 2017 office vacancy rate was 20.0%. Meanwhile Midtown South in Manhattan sported one of the lowest vacancy rates in the nation at 7.7%.
First quarter net absorption (the change in occupied space) totaled 6.8 million square feet, down 39% from levels observed in the same quarter one year ago and the smallest amount of space absorbed in just under five years. While slower, the record streak of positive absorption continued. The first quarter of 2017 marked the 26th consecutive quarter that space was absorbed off the market.
The national office vacancy rate appears to have bottomed out during the second half of 2016 at just above 13.0%. After hitting a cyclical low of 13.1% in the third quarter of 2016, the vacancy rate increased to 13.2% in the fourth quarter and remained unchanged at 13.2% in the first quarter of 2017.
“To be sure, the economy continues to add jobs, and most U.S. markets remain fundamentally healthy,” said Cushman & Wakefield Global Chief Economist Kevin Thorpe. “But the combined pressures of slower job creation and rising office construction is beginning to place upward pressures on vacancy rates, particularly in the larger U.S. cities. Although absorption levels are expected to remain healthy, given the growing supply pipeline, it is likely that we have reached an inflection point in the cycle where we will observe a gradual uptrend in U.S. vacancy rates for the next 12-18 months.”
In the fourth quarter of 2016, the U.S. economy created 51,000 office-using jobs per month, a slowdown from the 83,000 jobs per month added in the third quarter. The slower pace of office-using job creation has continued into the first two months of 2017, averaging 59,500 per month. In the first quarter of 2017, approximately 11.6 million square feet of new office space was completed and delivered in the 87 office markets tracked by Cushman & Wakefield, while 6.7 million square feet of space was absorbed off the market.
In terms of office construction, a quarterly average of 6.2 million square feet of new buildings were competed from 2010 to 2014. That has more than doubled to 13.0 million square feet in the past two years, and the new-construction pipeline remains high. At the end of the first quarter there was 102.8 million square feet under construction, the second highest volume of the past 17 years. Just three years ago, the construction pipeline was approximately 67 million square feet, so it has increased by 53%.
“We have observed two major shifts in the office sector over the past two years,” said Ken McCarthy, Cushman & Wakefield principal economist, applied research lead. “The first was that tenant demand in the country’s technology hubs began to cool off, and that trend has continued into early 2017. The second shift is occurring on the supply side. Developers are clearly cranking it up, but the space is mostly getting delivered in places that need it most.”
The majority of the construction pipeline—51%—is concentrated in markets that have absorbed large volumes of space throughout this expansion, led by Manhattan (12.0 million square feet of new supply in the pipeline), Silicon Valley (6.3 million square feet), Dallas (5.9 million square feet and San Francisco (5.1 million square feet).
For office vacancy, the tightest market in the nation was Nashville with a 6.9% vacancy rate, followed by Raleigh/Durham (7.3%), Midtown South Manhattan (7.7%) and Seattle (7.7%). Notable improvements occurred in Palm Beach, CA where vacancy fell 2.2% in the first quarter of 2017 from the prior quarter, followed by Baltimore (-2.1%) and St. Petersburg/Clearwater, FL (-1.8 %).
The average asking rent on available space in all markets, suburban plus central business district (CBD), reached $29.96, up $0.49 or 1.7% from the fourth quarter and 4.6% from a year ago. Since the bottom of the cycle in the first quarter of 2010, average asking rents have increased 19.5%. Five metro areas recorded double digit year-on-year rent growth in the first quarter: Brooklyn (+16.5%), Oakland/East Bay (15.0%), Palm Beach (+13.9%), Nashville (+13.8%), and Seattle (+11.0%). San Francisco continues to hold the top spot in terms of rent growth in this cycle. Since the first quarter of 2010, asking rents in San Francisco have increased by 119.9%, Cushman & Wakefield stated.
In terms of highest average rents achieved, Manhattan continues to lead the pack with all three CBD markets in the top five: Midtown Manhattan tops the list with average asking rents of $78.83 per-square-foot, followed by Midtown South Manhattan ($71.48), San Francisco ($69.66), San Mateo ($58.74), Downtown Manhattan ($58.54) and Washington, DC ($53.21).