Is the Office Market Finally Ready for Recovery?

By Keith Loria, Contributing Editor

While the resurgence of the U.S. economy has driven strong performance in the housing and retail markets, the office market has been much slower to find its footing.

“There’s been a bit of a disconnect in economic growth over the last two or three years in the U.S. in the performance of the office market,” observed David Versel, Transwestern’s senior vice president of research. Transwestern and Delta Associates just released the third-quarter edition of “Insights + Trends + Opportunities,” featuring a review of the economy’s impact on commercial real estate. “Through the economic recovery, there just hasn’t been a strong response from the office market nationally, with a few notable exceptions.”

The report shows that during the first half of 2015, the trends have been mostly positive in the nation’s largest metro areas, positioning the office market to continue gaining momentum in most metros. According to Versel, as the economy continues to improve, the hope is that the office market will improve with it.

Office vacancy remains elevated in several major markets, particularly Philadelphia, Atlanta, Chicago and Los Angeles. Overall, San Francisco, New York and Denver maintain the lowest vacancy rates, all below 10 percent, but other major markets remain above 10 percent.

In fact, direct average marketing rents came in above $55 per square foot in New York and San Francisco, much higher than in any other major metro, with no other markets approaching even $37 per square foot.

Meanwhile, in most cities, office tenants are looking for fewer square feet per employee, contributing to higher vacancies.

“In Washington, D.C., it’s been a rampant trend among law firms, responsible for probably a quarter of the space in the District Proper,” Versel said. “As leases come up for renewal, they are looking for smaller spaces, but higher quality at the same time.”

Most major metros are in the early stages of market expansion at this time. The two outliers are Houston and Philadelphia. In Houston, a large supply of office space is set to come online but a weakened economy is likely to limit absorption. Philadelphia has experienced weak rent growth and no pressure for new construction. Others to keep an eye on are Atlanta and Miami.

“One market that has to improve, if you look at the job growth going on there, is Atlanta,” Versel said. “It took a severe beating during the recession, but if you take a look at the report, vacancy remains very high and there’s very little construction going on there. There’s also some healthy rent growth from earlier this year, and the Atlanta region is expected to add close to 100,000 jobs this year.”

Outside the city cores, the death spiral of the suburban office park is picking up momentum. Vacancy tends to be highest in the old model of low-density suburban office campuses with large surface office parks, according to the report.

“A lot of that has to with employee attraction and retention,” Versel said. “Young workers do not want to work in that environment. They want a more urban, mixed-use environment, where they can walk someplace to lunch or hang out after work.”

You can download the full report here.