Reality Check: US Office Space Mkt Down Sharply, Brokers Say
10:25 EDT 05/11 --Decline In Office Demand During 2001 "Jolts" Industry --Vacancies Rise Sharply, Decline In Rents Difficult To Measure --Anecdotal Evidence that 1Q Slowdown Should Persist Into Summer
By Gary Rosenberger
NEW YORK (MktNews) - The commercial real estate market appears to have given up much of its year 2000 gains in what industry officials describe as a "jolting" slowdown in 2001.
Vacancy rates in the nation's hottest office markets loosened sharply in the first quarter, dragging rents down with them, say officials for commercial real-estate brokerage firms.
But the consequent declines in rents are difficult to measure because landlords attempt to stave off price declines with "concessions" while trying to keep "asking prices" elevated.
Brokers blame the surprise increase in vacancy rates primarily on the fact that too much new office construction has come on line that was financed and planned when a slowdown wasn't foreseen.
Preliminary data, some still unreleased, "shocked" the industry and created nervousness about the second quarter and beyond, said Robert Bach, national director of market analysis at Grubb & Ellis, among the nation's larger commercial real estate firms in Chicago.
"The first quarter was a shock to the system," Bach said. "It was a sharp reversal of the tightening market we saw during all of 2000. The overall vacancy rate shot up."
Grubb & Ellis's preliminary figures show office vacancy rates nationwide soared to 10.37% in the first quarter from 8.86% in the fourth quarter.
"Nobody expected things would be this bad," he said. "We kept congratulating ourselves for the way we kept the market cycle under control. The negative absorption rates jolted people to question their prior logic."
Bach added that the vacancy rates, while shocking, remain within what would historically be considered a "balanced" market.
The major markets that experienced the sharpest vacancy increases were Boston (up 409 basis points), San Francisco (up 379 basis points), Chicago (up 378 basis points) and Miami/Dade County (up 292 basis points). By contrast, Manhattan got off easy with that market loosening by just 83 basis points in the first quarter.
"New York's economy is more diverse, and even though it has a lot of technology startups, it's not as big a percentage of the total economy as it is in Boston or San Francisco," Bach said.
Chicago's problems might be more indicative of what's going on in the rest of the nation. Bach said Chicago's absorption rate was a negative 693,000 square feet (downtown and in the suburbs) during the first quarter, as demand clearly lagged the amount of fresh supply.
Bach estimates 70% of the vacancies are due to too much new construction, versus about 30% stemming from the travails in technology and other downsizing sectors of the economy. "New construction is the chief culprit in vacancies going higher," he said. "Dotcoms clearly have an impact but it's minor compared to space still coming on the pipeline with low levels of preleasing."
He said official figures don't properly account for the subsequent drop in rents because surveys of "asking prices" exclude the impact of concessions -- a month's free rent or tenant improvement allowances.
On the face of it, the rent declines were minor -- Bach estimates asking prices were down just 0.7% in the first quarter, but "that number doesn't reflect concessions."
On top of that, leasing velocity is so weak in some areas that there is no way to get an accurate read on rents. "If there are no deals being done, how do you figure out how to price space," he asked.
Bach estimates that the hardest hit market, San Francisco saw rents down sharply from its peak in the third quarter but is still slightly above year-ago levels.
At the end of the first quarter, San Francisco office space averaged $70 a square foot, versus $85 in the third quarter and $68 in the first quarter of 2000 -- but again, prices would be lower if they included concessions.
Bach said he expects office markets nationwide to drop further in "the next two to four quarters as more new office buildings come on-line with very little leasing and as tenants go out of business."
A further sign of stress is the nationwide surge of sublease space to 61.7 million square feet in the first quarter, from 45.7 million square feet the previous quarter.
"Another fear is those April jobs numbers, which were so strongly negative. There is a direct correlation between employment and demand for office space," he said.
Bach "takes some comfort" in low interest rates and continuing strong levels of consumer spending but doubts that the office market will return to its formerly vigorous levels. "The economy might not bounce back at all, just crawl out of it hole," he said.
Jon Southard, chief economists at Torto Wheaton Research, the economic forecasting division of CB Richard Ellis in Boston, said his first quarter numbers remind him of the recession of the early '90s.
"We reported 16.9 million square feet of negative absorption in the first quarter -- that's the worst number we've had since we began reporting quarterly numbers in 1988," Southard said.
"That's significant because it's worse than the 1990s recession for the office market," he said. "We also reported a record amount of sublease space -- and the assumption is that that's the dotcom firms dropping out."
Southard noted the repercussions on "marquee" rent asking prices have yet to be felt anywhere but San Francisco. But there are anecdotal reports of landlord concessions that amount to rent drops. "Right now nobody has a good handle on where the economy is going or when it will recover -- but we still think it could end quickly," he said.
"We believe it's a psychological phenomenon -- landlords and tenants are sitting on the fence to see when the slowdown will end," he added. "Right now it's a waiting game with tenants waiting for things to get worse and landlords waiting for things to get better."
Another commercial real estate firm's data agrees that a slowdown has taken place, but an official there paints a more optimistic gloss on recent events.
"We feel it's a market correction from last year, which was an anomaly," said Ann Covell, director in the analytics department at Cushman & Wakefield, an international real-estate service firm based in New York City.
Covell noted, for instance, that the San Francisco market saw asking prices soar by 55% last year, while New York saw prices up in the 38% range. "That's what you call a spike," Covell said. "We've never before seen rents jump like that in one year."
While the repercussion are negative for the commercial real-estate market, "the sky is not falling ... unless you're a dotcom firm," she said.
She prices San Francisco's office space market at around $74 in the first quarter, versus $80 at year end and $68 at the beginning of last year. New York's midtown, the most expensive real-estate in the city, was essentially flat in the first quarter at about $68 from the fourth quarter, but still up from $53 in the first quarter of 2000.
She too emphasized that current asking prices do not account for landlord concessions, but "we're still experiencing strong rents."
"We think that in the second quarter we'll see rents dropping more and vacancy rates increasing -- but we see it as a V-shaped slowdown and recovery," Covell said.
She argues that despite the slowdown from overheated levels in 2000, the market remains balanced -- and prospects are good for a recovery by year end or the first quarter of 2002.
"The basic brick and mortar fundamentals are still sound," she said. "Vacancy rates are still below equilibrium in most markets and rents are still strong."
She also believes that, in the central business districts of major markets, new construction still generally lags demand, particularly in New York where 6 million square feet under construction is "almost all preleased" and is a scant 1.5% of the 400 million square of inventory.
The major exception is San Jose/Silicon Valley/San Francisco, where new construction represents 18% of inventory, a figure that seemed justified at the planning stages more than a year ago -- "but where circumstances have changed."
Covell "overlayed" vacancy rates, rents and new construction against four previous recessions and said this slowdown roughly compares to the short recession of 1982, but falls well short of the early '90s recession.
Cushman & Wakefield data shows central business district vacancy rates at 8.3% in the first quarter, versus 7.1% in the fourth quarter and 8.0% a year prior. Suburban vacancy rates were at 12.2% versus 10.4% in the fourth quarter and about 11.0% the year prior first quarter.
By contrast, central business districts saw vacancy rates at "almost 20%" in 1992 and suburbs saw a 22% vacancy rate in 1991, she said.
Editor's Note: Reality Check stories survey sentiment among business people and their trade associations. They are intended to complement and anticipate economic data and to provide a sounding into specific sectors of the U.S. economy. |
