By Kevin Thorpe, Chief Economist
Tenant demand for office space slowed in the first quarter, dragged down primarily by continued weakness in the oil patch and a pullback in the tech sector. Still, net absorption remained strong enough to push occupancy levels and rents higher in most markets.
Following the strongest level of demand in nine years, total U.S. net absorption of office space slowed by 59% in the first quarter from the previous quarter to 9.7 million square feet (msf). Despite the deceleration, tenant demand for office space kept pace with new construction. The national office vacancy rate remained flat at 13.5% – its tightest level since the third quarter of 2008.
The slowdown mirrors the choppy performance of the U.S. economy, and was concentrated in certain markets. The financial market volatility that marked the start of 2016 weighed heavily on the tech sector, and for the first time in years we saw the venture capital faucet tighten and certain tech hubs such as Silicon Valley and Boston began to pull back.
Conditions have stabilized after the first six weeks of the year, and U.S. businesses continued to add jobs at a healthy pace. Given that job creation and consumer confidence have remained steadfast, we should see the office demand metrics pick up from here.
In the first quarter, the top 10 strongest markets in terms of demand were Dallas/Fort Worth, with 2.2 msf of absorption; Denver, with 909,000 sf; Miami, with 907,000 sf; Philadelphia, with 818,000 sf; Phoenix, with 725,000 sf; Charlotte, with 670,000 sf; San Diego, with 623,000 sf; Seattle, with 612,000 sf; Austin, with 581,000 sf; and Palm Beach with 518,000 sf.
U.S. office rents increased 4.1% in the first quarter compared to a year-ago to $28.45. The construction pipeline expanded modestly for the quarter, with 9.5 msf of new office buildings delivered to the market and 95.1 msf expected to deliver over the next two years. Both readings were down slightly from the first quarter of a year-ago.
The highest office rents continue to be in Midtown Manhattan at $78.40 per square foot, but San Francisco, which has the lowest vacancy rate in the country at 5.7%, has closed the gap with asking rent averaging $68.44. As recently as the beginning of 2010, the difference between Midtown Manhattan and San Francisco was $30.30.
The top 10 markets this quarter in terms of rent growth were San Jose, with 22.1% year-over-year rental appreciation; Dallas/Fort Worth, with 17.5%; San Mateo County, with 16.5%; San Diego, with 13.5%; San Francisco, with 12.4%; Miami, with 11.8%; Palm Beach, with 11.7%; Seattle, with 11.6%; Puget Sound-Eastside (formerly Bellevue), with 10.4%; and New York (Midtown South), with 8.4%.
A number of factors indicate the U.S. office market will continue to tighten. Developers and lenders have held to a disciplined approach to new construction throughout this cycle. The combination of equity market declines early in the quarter and continuing weakness in energy-driven markets has reinforced this discipline.
As a result, the office sector is underbuilding relative to office-using job creation. So even when the economy throws a weak absorption number on the board, vacancy stays tight. If job growth continues to follow a similar script, we are going to see rent growth spike to double-digits in a growing number of markets this year.
Kevin is Cushman & Wakefield’s Global Chief Economist, focusing on global economic trends and forecasts. He and the firm’s worldwide research team produce studies and statistics on topics affecting the global and U.S. economy, capital markets, finance, leasing fundamentals, property and project management and factors that affect supply-demand fundamentals in commercial real estate. Mr. Thorpe has developed several econometric models to predict market trends, is a member of the National Association for Business Economics (NABE), and has authored numerous studies and survey reports. He is also frequently quoted in publications. In 2014, Mr. Thorpe was recognized as the nation’s most accurate economic forecaster with the NABE’s Outlook Award.