Office Markets Deliver

Source: CoStar Group Inc.

Source: CoStar Group Inc.

Office completions totaled 52 million square feet for the past year, including 19 million square feet in the fourth quarter of 2014—a 21 percent increase from one year earlier. The level of in-process construction is fairly close to the long-term average. Of the 107 million square feet of in-process construction, Houston’s 18 million square feet stands out as a very active supply pipeline. And there is another 5 million to 7 million square feet under construction in New York, Chicago, Boston, Dallas, San Francisco, San Jose, Seattle and Washington, D.C. In fact, roughly a third of the office markets now have construction activity that is above historical averages, which is likely to constrain future rent growth in those markets. As rents rise and vacancies fall, more markets will be joining the construction pipeline.

On the other hand, when measured by deliveries, industrial development remains limited. During the fourth quarter, developers completed just 31 million square feet across 31 markets and 169 buildings. However, the development pipeline is expanding rapidly. At the end of 2014, 130 million square feet was underway, a significant increase from the 95 million square feet tracked a year earlier. Even more notable is the anticipated total for first quarter 2015. Deliveries are expected to exceed 61 million square feet, which would make the beginning of 2015 one of the strongest quarters on record. Not all markets are equally active, but among the leaders are Chicago (with 70 million square feet), the Inland Empire (with 53 million), Dallas (35 million), Kansas City (34 million), Phoenix (30 million) and Atlanta (28 million). The area where proposed space is extremely high relative to total stock is the up-and-coming Pennsylvania corridor, with 36 million square feet of proposed developments, or 16 percent of total stock.

Generally speaking, enthusiasm for retail development is still tepid. But with tenants running out of options in some places, there will be a need for new product. An uptick in building will require two things: Tenants must demand new space if they are unable to find existing space that meets their specific needs, and rents must be high enough to justify construction. These criteria are most easily met in supply-constrained metros in which the fundamentals recovery has been outsized. New York is a good example, as its rents are back in line with pre-recession levels. Correspondingly, New York has several new malls in the pipeline that will deliver over the next few years. Markets that don’t meet both criteria should continue to see strong fundamentals improvement as demand runs ahead of supply.