March Issue: It’s Alive! Rebirth of the 9-5s

Call it the Comeback Kid. After taking a beating from the recession, in 2014 office leasing got off the mat and then some, enjoying the strongest demand in eight years.
LL’s leasing team signed a tenant to a full floor at 1920 McKinney, a Class A office development in Dallas’ Uptown submarket (above).

LL’s leasing team signed a tenant to a full floor at 1920 McKinney, a Class A office development in Dallas’ Uptown submarket.

Call it the Comeback Kid. After taking a beating from the recession, in 2014 office leasing got off the mat and then some, enjoying the strongest demand in eight years.

Leasing volume hit 22.4 million square feet nationwide in the fourth quarter, up 48 percent year over year, according to DTZ’s fourth quarter U.S. office report. That put the exclamation point on a year during which the office sector absorbed 71.7 million square feet, the best performance since 2006.

“In the last year or so, office demand is coming back,” Alexander “Sandy” Paul, executive vice president at Delta Associates, told Commercial Property Executive. “The fact that jobs are now being created in office-using sectors—most important, professional and business services—that is driving renewed demand in the office market.”

Underscoring Paul’s point about the impact of good economic news, real GDP grew at a robust 5 percent during the third quarter of 2014 and the average national vacancy rate fell 30 basis points during the third quarter, ending the year at 14.5 percent. Although vacancy has yet to reach normal levels, fundamentals in most markets are tightening at the speed of lightning, according to DTZ.

“We’ve entered 2015 in the tightest office market since the end of 2006/early 2007, and that’s really being driven by an economic environment domestically that’s a lot more positive on the GDP front, on the job-creations front, on the corporate front,” John Sikaitis, a JLL managing director & office-research specialist, told CPE.

“The difference between now and 12 to 14 months ago is companies are now reinvesting back into their revenue streams, they’re reinvesting back into the business, back into real estate,” he added.

Source: DTZ Research

Source: DTZ Research

Recently, JLL forecast rent increases of 13 to 14 percent nationally over the next 27 months, driven by a new wave of development.

Thanks to positive momentum, landlords are “gaining confidence in the market, and for the first time we’re seeing viable rent growth across the board,” Sikaitis added.

That said, rent growth is strongest in several urban clusters and in suburbs that offer similarly vibrant downtown settings. By contrast, the typical suburban office campus will continue to decline and gradually become obsolete, according to Paul.

“Most tenants are seeking a mixed-use environment where workers can walk to lunch spots or do some shopping on their lunch hour, have easy access to transportation,” he said. Paul noted that the dearth of development during the recession is helping keep the lid on vacancy.

And despite the recent uptick in construction, much of that activity is concentrated in places with strong energy and technology sectors, like the big cities of California and Texas.

Those markets are likewise showing a spike in tenant decisions to expand in place. “Developers will be aggressive in trying to land tenants in those markets,” said Sikaitis.

Increases in net absorption varied dramatically by region in 2014, according to DTZ. Absorption jumped 89 percent in the West, 36 percent in the South and 1.2 percent in both the Midwest and Northeast. (CoStar’s forecast based on fourth-quarter performance appears in this month’s Data & Analysis section.)

In 2014, New York City took the top spot for demand, tallying 9.2 million square feet of net absorption, according to DTZ. The runner-up, Houston, absorbed 6.6 million square feet, followed by San Jose, Dallas, San Francisco, Denver, Phoenix, Seattle and Boston (see chart above for details).

In rent growth, however, San Francisco led the pack by a wide margin. Its 17.2 percent average price hike was nearly double the solid 9 percent increase recorded by Houston, its closest competitor.
Rounding up the top 10 were New York City (8.5 percent), Phoenix (7.3 percent), San Mateo County, Calif. (6.9 percent), San Jose (6.4 percent), Dallas (5.5 percent), Denver (5.4 percent), San Diego (4.4 percent), Raleigh, N.C., (4.3 percent) and Austin (4.2 percent).

Regarding the implications of the office sector’s surge for lending, two schools of thought are emerging. Sikaitis tends to take the optimistic view that the improving economy and office sector fundamentals have raised lenders’ confidence levels. As a result, his team is noticing relaxation of underwriting and increased receptivity to speculative development.

Meanwhile, Paul detects a more cautious tone from lenders. He finds that many are still gun-shy after the recession and tread carefully when it comes to financing spec projects.
Yet even with that caveat, Paul believes that the office market is basically sound, and his advice to tenants reflects that view.

“(Office) tenants who need to add space, they have tremendous leverage that has not been common in the marketplace,” he said. “Act relatively soon if you’re a tenant that needs to add space, because there are still great deals to be had.”