The first quarter marked another positive chapter in the U.S. office market’s recovery. The sector that suffered for several years is now experiencing the effects of ongoing job and economic growth, leading to positive net absorption, increasing rents and new construction in many major markets.
The U.S. office market had an excellent first quarter. Walter Page, director of research at CoStar Group, reported rents were up 3.7 percent on a year-over-year basis, and net absorption was 74 million square feet, up 20 percent from a year earlier.
“Of the 54 markets we track, 53 had positive absorption for the past year, six markets more than the previous year,” Page said. “Fifty markets are achieving positive rent growth, and 15 markets have vacancy that’s less than 10 percent. Overall, it’s a good time in the office market.”
Driven by its strong technology sector, San Francisco’s office market is one of the strongest in the country. “We are experiencing a new gold rush in San Francisco, and the mother lode is downtown,” proclaimed David Ford, senior vice president at Transwestern.
San Francisco has seen 15 quarters of strong demand. The current vacancy rate is around 8 percent, with rental rates as high as $70 per square foot. Class A institutional properties are trading for an astounding $700 per square foot, Ford added.
Rightsizing among tenants is still continuing. One example is the U.S. General Services Administration (GSA), which recently consolidated its headquarters at 1800 F Street in Washington, D.C.. There are very few private offices and desks are no longer an employee’s exclusive space. There are two employees per desk, which is reserved online. The cost savings are significant.
“At our headquarters, we collapsed six leases, which will save us $24.4 million a year in rent,” said Bob Stafford, director of the internal workplace management division at GSA. “We are also saving $8 million a year in administration costs. That’s a significant amount of tax dollars being saved.”
By the end of 2016, 3,000 or nearly 35 percent of the GSA’s leases are set to expire. “We will continue to work with [our federal agency] customers to right-size our inventory,” Stafford added.
Construction Picks Up
A flight to quality in the office market is continuing, driving new construction. “Tenants want Class A space but they are increasingly not finding what they are looking for, which is driving new construction and a shift to demand in Class B space,” Page added.
The number of projects under construction totals 85 million square feet, up 15 percent from a year ago, according to CoStar. At this point, construction is up 77 percent from the low point in the recession.
The bulk of new construction is still build to suit, but some speculative projects are starting as well, Page said. New construction is starting to expand, but is mostly isolated to big markets such as Houston; San Jose, Calif.; San Francisco; Washington, D.C.; and New York.
Steady First Quarter for REITs
In the first quarter, total returns for office REITs were up 11.25 percent from the previous quarter, said Calvin Schnure, vice president and chief economist at NAREIT.
“REITs struggled in the second and third quarters last year when the Fed started talking about when they might taper the stimulative quantitative easing policy and what their eventual exit from the policy would be,” Schnure said.
Looking ahead, Schnure anticipates moderate growth for REITs, reflective of the overall economy. “Office REITs deal with properties that are driven by job growth, which has been struggling, but we’ve seen some improvement,” he added. “We are optimistic that we will see long, steady improvement in the office sector.”
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