The US office market continued to tighten up in 2014 and we’ve seen a shift in leverage from Tenants (as reported earlier in the year) to Landlords nationally. Vacancy declines were reported across the board, but fell into single digits in some major markets. Expansion plans came off the shelf as uncertainty waned in response to an improving US economy. The energy and business services sectors led the way in office-using job creation, which resulted in more big moves from corporate users. As a result, large space blocks are becoming scarce in markets where employment growth is strongest.
Development activity picked up, both on a speculative and build-to-suit basis, but new deliveries were sporadic, making it more difficult for larger users to relocate. Some businesses have decided to commit early and await for new construction due to the short supply of quality first generation space.
Class A space in and around urban cores saw the biggest gains as many users showed a willingness to pay higher rates to gain efficiencies realized through open floor plans and new communication technologies. The new look and feel is not only preferred by the millennial workforce, but it has also reduced the amount of space required for each employee. Markets heavy in energy and technology saw the biggest net gains in occupied space for the year.
Concerned over further rental rate hikes, more tenants have opted to sign longer leases. Class A space in major markets including San Francisco and New York led the way while Class B rent growth was mixed. Activity in some suburban submarkets, lacking the amenities of more urban locales, did not keep pace with big move-outs, which resulted in flatter rent growth.
Investor interest in office properties intensified in 2014. Cap rate compression continued as domestic institutions competed aggressively with foreign buyers, flush with cash and anxious to find a safer haven for their capital. However, demand for class A product outstripped supply in virtually every metro area of the country. That has forced investors into suburban areas and increased their willingness to take on more leasing risk. Older projects, proximate to public transportation and retail amenities, attracted more interest from add-value buyers willing to modernize to achieve higher rents.
Driving all this activity was an overall economy that steadily improved over the course of the year. A closer look at key economic drivers brings 2014’s office market performance into clearer perspective.
After several years of anemic GDP growth the nation’s total output finally broke into new territory in 2014. Job and wage growth, weaker in this recovery by historical standards, stepped up the pace in 2014. The unemployment rate moved down significantly in 2014, falling to a post-recession low of 5.6%.
The US Federal Reserve Bank’s decision to hold the line on interest rates was another key driver and a bit of a surprise to many market experts. Concerns over global economic conditions grew deeper in 2014. The fall in energy prices worldwide was the big surprise in 2014.
The US office market will keep moving along its present course in 2015. Domestic GDP and job growth will be robust enough to overcome ongoing concerns over external forces.
Low Energy prices will give consumers a boost, which should fuel additional office leasing activity and job creation. Energy states like Texas will see slower job growth, but net employment gains in other sectors will minimize the impact.
For the moment, the Fed continues to reassure the markets that the cost of capital will remain low in the short term. That will keep vacancy moving lower and net absorption on pace with or ahead of 2014 levels for the next several quarters.
Net absorption will moderate in markets with the lowest vacancy, as fewer relocation options force tenants to stay put.
Cap rates will remain compressed and development will be limited by the availability and cost of land, especially in the most mature markets.
Expect the Affordable Health Care Act to return to center stage in the media and in corporate board rooms, as new employer mandates kick in and the US Supreme Court rules on a key component of the law that could unravel its financial underpinnings.
Click the following link to download The Lee Office Brief. Q4 2014 Office Brief.pdf
Michael Staskiewicz, CCIM is the Managing Broker/ Senior Vice President of The Garibaldi Group and Founder of EffectiveWorkplace.com. Michael helps innovative, purpose-driven CEOs clarify the strategic plan for a world-class work environment, so they can attract the best talent and reduce voluntary turnover.