Market Report April 2014 by Randyl Drummer

by Craig West on 5/2/2014

*The U.S. office recovery continued to hum quietly along in the first quarter, absent any dramatic surges or spikes. As a result of the measured pace of increasing tenant demand, the national office vacancy rate remained unchanged from the previous quarter at 11.9%, according to CoStar’s First Quarter 2014 Office Review and Outlook.

*Overall net absorption of U.S. office space is running ahead of last year’s pace with 74 million square feet absorbed over the last 12 months, compared with 61 million square feet during the previous year period through first-quarter 2013. Also, the 16 million square feet of office space absorbed in the first three months of 2014 is an increase of nearly 78% over the 9 million square feet logged in the first quarter of 2013.

*“The office recovery has now reached the halfway point,” said Walter Page, CoStar Group director of office research, who presented the quarterly update along with Managing Director and Chief Economist Hans Nordby and Aaron Jodka, manager of U.S. market research.

*“We expect a slow and steady straight-line improvement in the vacancy rate to 11.1% by 2016,” Page added.As expected, office vacancy is continuing to decline at a rate of about one-tenth of a percent per quarter, decreasing 50 basis points from a year ago to 11.9% in the first quarter, which is unchanged from fourth-quarter 2013.
“We’re going to cross the long-term vacancy rate of 11.7% in the next quarter or two,” Page added. Vacancy rates are dropping below 10% in major metro areas throughout the country, setting the stage for strong rental rate growth.

*Driven by the technology boom and the rapidly accelerating housing recovery, suburban office markets have accounted for the lion share of leasing activity, generating 83% of total U.S. net absorption over the last year.

*And more markets are joining the recovery, particularly in the Midwest, with CBD markets such as Cleveland, Detroit, and St. Louis, and suburban markets such as Kansas City, are now seeing rising demand. But the Houston suburban market remains the biggest story of all, logging a staggering 7.7 million square feet of suburban absorption over the last year.

*Cranes Rising in Multiple Markets

*Leasing brokers may have been sitting idle during early 2014, but developers were clearly getting back to work, with office construction seeing a bit of an uptick in the first quarter.

*With rental rates now rising in most markets, deliveries of new office space almost doubled in the first quarter from a year ago to 13 million square feet. Another 85 million square feet of rentable building area is under construction, compared with 74 million square feet in first-quarter 2013.

*Large build-to-suit projects are under way across the country, from State Farm’s 1.5 million-square-foot campus in Plano, TX, to Exxon’s 3 million-square-foot campus in Houston’s Woodland and the Prudential Tower in Newark, NJ.

*Speculative projects are also bearing fruit, such as the newly renamed 1.37 million-square-foot Salesforce Tower in San Francisco. The Internet-based company reportedly leased 700,000 square feet at a triple-net rate of $85 per square foot.

*Also in San Francisco, 222 Second St. in the South Financial District started as a speculative project. However, business-oriented social network LinkedIn has agreed to occupy the entire 452,418-square-foot building.

*Strong Rents Whet Investors’ Appetites

*Overall, rental rates are very strong in both CBD and suburban markets, with rents more than doubling their rate of growth from a year ago at this time, Page said.

*Average rents increased 3.7% in the first quarter, compared to growth of 1.5% in the first three months of 2013. At least nine major metros are seeing rent growth of more than 4%, led by San Francisco at 11.5% and New York City at over 6%.

*Free rent offered by landlords is coming down and tenant improvement packages are not as excessive as in the past, Page said.

*According to preliminary CoStar figures, U.S. office investment sales rose 22% in the first quarter compared with a year ago.

*The $112 billion in office sales over last 12 months leads all property types, and four-quarter average sales volume has been steadily rising, according to Nordby.

*In one of the quarter’s largest transactions, The Blackstone Group sold the 572,153-square-foot 28 State St. to a joint venture of the Rockefeller Group Development Corp. and Mitsubishi Estate New York, Inc. for $355 million, or $620 per square foot.

*“The wild card in the capital stack in terms of how many sales there will be is how many will be if Blackstone continues to unload its office portfolio,” Page said.