Catching Up to the Recession

The most surprising metric for the office market last year was that, despite the recession, net absorption totaled negative 3.4 million square feet, a paltry sum compared with the 111 million square feet of negative absorption during the 2001 recession and 2002-03 jobless recovery. Why hasn’t the office market reacted more forcefully to what will soon become the longest postwar recession? The most plausible explanation is that tenants haven’t had time to react. The labor market fell off a cliff in September 2008 with payroll job losses totaling 2.5 million during the five months since then. That’s on top of the 1.1 million jobs eliminated during the first eight months of last year, for a total of 3.6 million and counting. The office market lags the economy by six months as a rule of thumb. Look for absorption to fall deeper into the red over the next few quarters in response to the sharp deterioration in the labor market since last fall.However, the disciplined addition of new space over the past several years should help the office market deal with the recession. As a share of existing inventory, office space under construction reached a peak of 2.6 percent in the fourth quarter of 2007. Leading up to the recessions in 2001 and 1990-91, space under construction peaked at 4.6 percent of existing inventory in the third quarter of 2000 and 13 percent during the second quarter of 1986-Q2. Nevertheless, the 80 million square feet of space still under construction will push the vacancy rate from 14.8 percent at year-end 2008 to 16.5 percent as it comes online this year and next, and that is before any demand-side impacts—layoffs and negative absorption—are factored in. Expect the vacancy rate to end 2009 from 16.5 to 17 percent. In the first half of 2010, vacancy may top the prior peak of 17.9 percent recorded in the first quarter of 2004. Negative absorption will likely total 40 to 50 million square feet by year-end. Asking rental rates may be off 4 to 5 percent and effective rates 5 to 10 percent with sharper declines possible in specific markets.