Economy Watch: Office Market Health Hangs on Continued Job Growth

The continued recovery of the U.S. office market depends on the continued recovery of employment.

The continued recovery of the U.S. office market (or rather, all of the many metro markets that form that entity) depends on the continued recovery of employment. If jobs continue to be created at a pace of 250,000 to 275,000 per month — which has been the case until March’s under-performance in job creation — then “that would be a sufficient level to not only bring down the unemployment rate over time, but to gradually put more serious pressure on vacancy and upward pressure on rent growth,” said the first quarter office report by Reis Inc., which was published recently, as prepared by the company’s senior economist and director of research Ryan Severino.

Thus much depends on the creation of more jobs. But there are other positive indicators for the office market, according to the Reis report. One is that net absorption of office space nationwide was up about 6.4 million square feet during the first quarter of this year, which is a little slower than during the quarters of 2014, but still a relatively healthy amount. Suburban markets are actually doing fairly well when it comes to absorption, with the most recent quarter being the 16th in a row in which there’s been net positive absorption in the suburban markets. Part of that trend is because the suburbs have had, and continue to have, much further to go to fill their office space: Reis puts the average national CBD vacancy at 13.4 percent in Q1 2015, compared with an average of 18.7 percent for the suburbs.

Oddly enough, a majority of new-construction office projects are currently in the suburbs. That seems counterintuitive given the higher vacancy rates, but Severino posited that because of “the ongoing difficulty in obtaining construction financing for office projects, these are select properties. For example, enterprising investors have been targeting submarkets across the country with high vacancy but obsolete space, and are luring tenants via the prospect of shiny, new space signed at relatively cheap rents.” The trend might accelerate, too, since a lot of the leases signed at the bottom of the market (during the worst of the recession) are going to expire in the next few years, and if job growth continues at a reasonable rate, a lot of suburban tenants will find themselves wanting more space.

The Reis report also offered some observations about particular office markets of interest, such as Houston. That’s a closely watched market these days, since it’s widely anticipated that the drop in energy prices is going to have a negative effect on Houston. And so it has: net absorption has slowed a lot, barely registering positive in the first quarter. New office space continues to be delivered, however — such is the lagging nature of commercial real estate development — and so vacancies ticked upward by 60 basis points in the first quarter of  2015 to 15.1 percent, the highest level since 2011. Rent growth has slowed down as well, but not stopped, coming in about 1 percent for the quarter.