Office Developers Hold Off on Speculative Construction for Now

Office Developers Hold Off on Speculative Construction for Now

Though demand for office space continues to improve, industry experts say it’s still too early to expect a surge in speculative construction in the sector. Office developers are watching constructions costs rise and sensing some lingering caution from corporate executive teams, leaving them reluctant to build on a speculative basis.

Office hiring is still strong. National employment increased by 160,000 jobs in April, with professional and business services hiring 65,000 workers in fields requiring college degrees, such as accounting and design trades, and financial services adding 20,000 employees, according to a report by brokerage firm Marcus & Millichap.

Financial markets were fickle during the first quarter, but stabilized in April, according to a recent CBRE office trends report. While there was a slight decrease in in the first quarter of 2016 compared with the year-earlier period, there was an acceleration in office-using job growth, signaling stronger tenant demand for the rest of the year, according to Andrea Cross, CBRE’s head of office research for the Americas.

“Office-using employment has seen 26 quarters of positive growth, I would say the demand side is still holding up,” she says. “The growth we’re seeing now is in the markets that had been lagging after the recession, those in the Sun Belt where housing had trouble. The growth is not just San Francisco anymore, we’re even seeing it in Phoenix, Florida and the Carolinas.”

In fact, primary markets are seeing somewhat of a slowdown, at least from the strong gains made in the past couple of years. Construction is catching up to demand in cities including New York, where there was 25 million sq. ft. of class-A space available at the end of 2015, including 18 million sq. ft. in Midtown, according to a recent report by real estate services firm Savills Studley. Rent increases in New York slowed considerably in late 2015 and concessions have increased, according to Keith DeCoster, director of U.S. analytics at the firm.

“We are witnessing the early and tentative stages of transition from a landlord’s market to a tenant’s market, particularly in Midtown,” he said in a statement about the report.

Other markets with high construction volumes include Atlanta, with several million square feet of creative space and Houston, which is already suffering from losses due to low oil prices.

However, new office development is still muted in most of the rest of the markets, and Marcus & Millichap projects that net national absorption will reach 87 million sq. ft. this year, surpassing expected 2016 completions. Construction has been kept in check due to increased construction costs and a lack of available land, according to CBRE.

The tightening in space availability, particularly for big blocks of space in some markets, has led to tenants exploring well-located class-B properties, Cross says. Investors and developers are now chasing these properties in top markets for quick redevelopment opportunities. For example, Invesco Real Estate and Second Street Ventures just sold the 546,833-sq.-ft. Apollo at Rosecrans office campus in El Segundo, Calif. following a recent high-end renovation.

“I think there’s still enough caution to keep speculative office development at a minimum, you’re much more likely to see build-to-suit for those tenants who need big-block space,” Cross says. “Because of the higher construction costs, we’re going to need to see rents rise higher in most markets to experience a surge in speculative space.”

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