Office Landlords Toasting the New Year

Date: 01/30/2014

A landlord, a tenant and a broker walk in a bar. For the last five years the landlord might have been the one requesting the tequila shots. It’s the tenant who may desire the stronger libations in 2014. The broker, well, he picks up the tab.

Office property owners may be breaking out the bubbly this year as improving office sector fundamentals have picked up steam. Vacancy rates are declining across the country and rent growth in 2013 was at its highest level since 2007.

I recently sat down with an analyst, a landlord and a tenant rep on the “Commercial Real Estate Show” (we were drinking water) to get their view on what we should expect for office sector trends this year.

Tables Turning
“The office market is a good for landlords again,” said Jim Bacchetta, vice president of Highwoods Properties. “This is the busiest January I can remember in 10 years.”

In 2013, the office sector cracked 3 percent rent growth for the first time since 2007, said Walter Page, director of research at CoStar Group. Rent growth was 3.1 percent on a national basis.

The U.S. vacancy rate declined 50 basis points on a year-over-year basis to 11.9 percent, Page said. Nationwide, the market saw 59 million square feet of net absorption, a 20 percent increase from 2012, and only three markets tracked by CoStar had negative absorption for the year.

Surprisingly, net absorption was concentrated primarily in the suburbs, approximately 90 percent of total absorption in 2013. “Central business districts are having a tough time right now,” Page said. “The government and legal sectors are suffering, and there’s been a lot of space consolidation. Many technology companies are located in the suburbs, and the housing market is helping those markets significantly.”  

In 2014, occupancy will increase by approximately 60 to 70 basis points, Page said. Rent growth of nearly 3.5 to 4 percent is expected, however, “we aren’t going to return to the 8 percent rent spikes of 2007,” he added.

Space Wars

“There hasn’t been any new construction in five years in most markets,” Bacchetta said. “With steady progress and job creation, as well as another year or two of a dearth of new supply, we will continue to see increased pressure on rates.”

The lull in new construction means large tenants can sometimes have a tough time finding space — there’s just not enough supply in select markets, said Stuart Cott, president of corporate office services at Bull Realty.

In Highwoods properties around the country only a few markets like Tampa and Atlanta still have blocks of 100,000 square feet or more available, Bacchetta said. “Big blocks will be gone within a year,” he said.

Build-to-suit or highly pre-leased projects are on the horizon because of the diminishing supply. “We have development land in all of our markets,” Bacchetta said.

Space constraints are so tight in some markets that when large tenants are looking for space, simple availability can be a major concern, Cott said. Cost of living and the ability to hire also play an important role, he added.

 Lease Negotiations

Tighter supply has caused the landlord to have the upper hand in lease negotiations in some markets, Cott said. “As a tenant rep, we see the market as more challenging,” he said. “Good tenants with good credit can still find attractive leasing packages, but they aren’t as generous as they used to be.”

Flexibility should be a key consideration for tenants in lease negotiations, Cott said. “The ability to relocate within a building and grow or sublease your space is often overlooked by tenants, but it’s an important point to address.”

Landlords are negotiating less termination options, a big selling point during the recession, Bacchetta said. “Termination options diminish the value of your asset, and it’s something landlords have been bullied around with,” he said. “Tenants have started to back off a little, and we are saying no. We have a stronger position now.”

Of course, every market is different. A tenant’s leverage to negotiate attractive packages depends on its credit, space requirements, length of lease and the specific submarket.

What are the trends you see in your market? Might the landlord, tenant and broker all be clinking glasses this year? You’re invited to listen to the entire show on the U.S. office market at the Commercial Real Estate Show web site, CREshow.com.