Thank you to Ross Moore, Chief Economist at Colliers International for contributing this blog post today.
The U.S. office market looks set to finish the year on a more cautious note than earlier in 2011 and halt what had been a modest recovery characterized by a measured degree of optimism and a series of occupancy gains. A clear deceleration in economic activity and a near absence of job creation, however, has cast a shadow over the office space market. With the economy possibly coming close to stall speed, the outlook for the office space market has once again been called into question.
The lack of job creation of any significance lingers as a particular concern. Many metro areas are still far from firing on all cylinders, reflected by only lackluster growth in total non-farm employment: August data showed year-over-year growth of just under one percent. More encouraging, however, is office-using employment, which for the year ending August was up 1.5 percent, but two of the last three months were characterized by job losses in this key sector suggesting the annual growth rate is sure to come down in the coming months. Indeed, for the first eight months of 2011, monthly office-using job creation averaged 29,000, compared with 16,500 per month in the same period in 2010.
Despite these modestly favorable office job numbers, the outlook for the office space market is far from assured. Uncertainty is now a key feature of the business landscape. This is causing many business leaders to place expansion on hold or at least to scale back planned growth. Significantly higher energy costs are a distinct possibility, further monetary easing is in question and any additional fiscal stimulus is unlikely due to the policy paralysis that is characterized by the leadership in Washington. Combined with the ongoing European sovereign debt crisis, the brakes are now being applied to what was only a nascent economic recovery. The global economy, which had been a key source of growth, has clearly come off the boil and calls into question the vitality of U.S. exports which was one of just of a few bright spots.
Year-to-date data confirms our view that the U.S. office market landscape will continue to be uneven in nature and unusually volatile. Manhattan, Washington, San Francisco and Boston have led the country on the road back to a more normal market, however, Dallas, Denver, Houston, Philadelphia, Raleigh, San Diego, San Jose, Seattle and West Los Angeles are also showing encouraging signs. Beyond this relatively short list of cities, many markets have seen little pick-up leasing activity and continue to be characterized by a clear excess of space and no pricing power on the part of landlords. Any substantial increase in office rents is unlikely to occur in 2011, or 2012, and perhaps even into 2013.
The U.S. national office vacancy rate did nudge marginally lower during the first six months of the year, shifting 20 basis points to the downside. At midyear, office vacancies registered 15.26 percent and are on track to finish the year at or near 15.00 percent. During the first half, downtown vacancies decreased eight basis points to register 14.05 percent. Suburban vacancy rates pushed lower, falling 24 basis points to 15.91 percent. Over the past 12 months, the U.S. national office vacancy rate has fallen 41 basis points.
The keys to reading the U.S. office market correctly are still job growth, energy prices, monetary and fiscal policy and stable financial markets. Currently none of these variables can be predicted with any degree of certainty. For the near term, and quite possible the medium term, job growth will likely remain sluggish, energy prices elevated, monetary policy loose (although QE3 is unlikely), fiscal spending increasingly restrictive, and financial markets volatile. As a backdrop to office space demand, these signs are not altogether encouraging. For most landlords, attracting new tenants will be a challenge with little or no pricing power. Tenants, on the other hand, will enjoy at least another twelve months where they are clearly in the driver’s seat. This is not to suggest the recovery will never materialize, but with the domestic and global economy gearing-down, the new macro-economic environment has pushed the timing back to 2012 and quite possibly 2013. Not an overly optimistic outlook, but in all probability, realistic.