CoStar: Office Construction on the Rise in Secondary Markets

A new report by CoStar shows that while office construction hasn’t been a major factor in commercial real estate in 2013, due to rapidly improving fundamentals and rent growth that is reaching levels that justify new construction, many smaller secondary markets have a growing pipeline of planned projects that will have a significant impact on the market moving forward.

Nancy Muscatello, of Property Portfolio

A new report by CoStar reveals that while office construction hasn’t been a major factor in commercial real estate in 2013, due to rapidly improving fundamentals and rent growth that is reaching levels that justify new construction, many smaller secondary markets have a growing pipeline of planned projects that will have a significant impact on the market moving forward.

In the core markets, generally, the majority of expected deliveries through 2017 are already underway and the supply risks are well understood. In New York, for example, nearly all of the forecast construction through 2017 is underway today, while well over half the expected construction has started in Boston and Washington, D.C.

“The chief takeaway is that the office recovery has started to accelerate, and that the recovery is broadening beyond just the core markets of New York and Boston, where rents have been rising at a faster pace and starting to see the most construction,” Nancy Muscatello, senior real estate economist at Property & Portfolio Research, told Commercial Property Executive. “Now you’re starting to see construction beginning to ramp up in some of these smaller markets as rent growth has accelerated there as well.”

Based on CoStar’s analysis, Houston, Texas has 24 million square feet of construction currently underway or forecasted to begin soon, San Jose, Calif., has 13 million square feet, Atlanta has 10 million square feet, Seattle has nine million square feet and Nashville has six million square feet.

Large build-to-suit campuses planned by a handful of tech firms, such as Apple’s 2.8-million-square-foot campus in San Jose and Exxon’s 9.6-million-square-foot campus in Houston, could leave a surfeit of backfill space on the market in a few years when these projects complete.

“There might be some concern for overbuilding in San Jose and Houston where there are significant amounts of construction right now,” Muscatello said. “Where new construction is happening—the ones we noted, Atlanta, Nashville and Seattle—we do expect construction to ramp up and there will be significant compression in vacancy over the next year or so.”

According to Muscatello, office still lags behind multi-family and industrial projects, where construction is ramping up much more quickly. While multi-family recovery is essentially complete in the urban market, there’s still expected compression over the next 18 months for the office market.

The report shows that office construction underway comprises only 15 percent or less of total forecast supply in Austin, Denver, Seattle, and Nashville, below the national average of about 25 percent, and well under the levels in markets like Boston, New York, Washington, D.C., and even Houston.

“The recovery is broadening to more and more markets and that’s indicative of the pieces of recovery accelerating in these secondary markets and also the fact investor interest is moving from some of these core markets to secondary markets,” Muscatello concluded. “You’re starting to see capital flowing to secondary markets as well.”