Economy Watch: Office Market Recovery Accelerating

2015 might well be the best U.S. office market in terms of absorption and dropping vacancies since before the recession

Reis Inc. reported last week that 2015 might well be the best U.S. office market in terms of absorption and dropping vacancies since before the recession. During 3Q 2015, net absorption nationwide exceeded construction, causing vacancy to drop by 10 basis points to 16.5 percent, the lowest level since 2009. Slowly but surely, the recovery finally seems to have found its legs, with year-to-date figures for most metrics well ahead of 2014 as well. It’s been a little hard to notice the improvement, however. “Because the improvement has been so gradual, it has largely gone unnoticed by many in the industry,” said Ryan Severino, Reis senior economist and director of research. “Improvement is becoming stronger and more consistent, which portents better times ahead for the office market over the next five years.”

Overall improvements in the labor market are driving increasing demand for office space, the Reis 3Q report noted. Even though the most recent jobs numbers have been a bit weak, the number of total jobs created per month has gradually been on an upward trend in recent years. More importantly for office demand, the number of relatively high-wage, office-using jobs have also been increasing, at least since 2014. In the early 2010s, that wasn’t the case, and so the office market lagged behind due to the relative dearth of new office-using jobs. If the current trend continues, vacancy compression is poised to accelerate in the next year or so.

Then there’s the matter of absorption vs. construction. In 3Q, nationwide office absorption came in at about 9.86 million square feet. At the same time, about 7.67 million square feet of office came on line. For the first three quarters of 2015, total absorption totaled about 25.3 million square feet, which is about 5.3 million square feet more than for the same period in 2014. Also, while spec office projects remain at very low levels, well below previous cycles, they are returning to the market. Spec tends to be in markets that are at the strong end of the spectrum—northern California; New York; Washington, D.C.—or in markets with older inventories.

Improving fundamentals are also driving rent increases, both asking and effective. Asking and effective rents grew by 0.6 percent and 0.7 percent during the third quarter. Also, effective rent growth of 3.5 percent year-over-year is strong, especially considering that vacancies are still relatively elevated. “To put that in context, year-over-year effective rent growth in the office market is roughly in par with year-over-year effective rent growth in the apartment market,” said Severino. Even so, the increases are “being somewhat inflated by a relatively small number of very strong markets which are having an outsized impact on the national data.”