Office tenants mindful of uncertainty and turmoil expected in the year ahead exercised caution with expansion plans in the first quarter, resulting in a slight increase in office vacancy as new supply came on-line.
Reports by real estate services firms JLL and CBRE show that the national vacancy rate rose to an average of 13.2 percent, a 10 basis point increase from the fourth quarter of 2015. However, even with the increase, the rate remains at the lowest level since 2008, and the expected project deliveries will barely make a dent in demand. The nearly 47 million sq. ft. in new supply expected by December is already 54 percent pre-leased, according to JLL.
Leasing volume has been down recently because of stock market volatility and concerns over the economic slowdown in China and low oil prices, notes Julia Georgules, vice president of office research for JLL. Relocations and lease renewals dominated activity in the first quarter, at about 16 million sq. ft., compared to about seven million sq. ft. taken off the market due to expansions and new leases. “With the uncertainty, you saw tenants take a wait-and-see attitude to how things are going to shake out this year,” Georgules says.
Another reason for the deceleration in leasing momentum is the growing belief by some economists that the technology bubble, which has been the main fuel for the growth in office demand since the recession, could soon burst. “There’s been a recent concern over valuation and a lack of IPOs, and the venture capitalists who funded it all are now sitting back and taking a hard look at growth projections,” Georgules says. “They’re starting to be more conservative about where to expand.”
That thought process has been brought on by the rise in rental rates, especially in markets dominated by technology tenants. Tech-heavy markets such as San Francisco have experienced the strongest demand, and boast the lowest vacancy rates, according to JLL. The national average direct asking rent climbed to $32.28 per sq. ft. in the first quarter, with some markets seeing whopping increases, such as Silicon Valley’s 15.8 percent and Oakland-East Bay’s 9.7 percent.
Such rent hikes have pushed tenants to consider less expensive locations for growth, according to Georgules. “Corporate occupiers are looking to secondary and tertiary markets such as Denver, Nashville or Austin, where costs are better,” she says. “Some firms are moving back office or administration jobs to those lower cost markets while they keep the executive level in the main market headquarters. If a company needs to be in a major urban market to attract top talent, however, that’s still a priority.”
The increase in office vacancy this year was also caused by significant levels of new supply coming to certain markets, including Boston, Dallas and Washington, D.C., said Jeffrey Havsy, chief economist for the Americas with CBRE, in a statement. A total of 13 markets had higher vacancy rates than in the first quarter of 2015, including Houston, Pittsburgh and Denver. However, other markets experienced outsized occupancy growth in the first quarter, led by Detroit at 130 basis points, and followed by Nashville, Ten.., Louisville, Ky., Columbus, Ohio, Cleveland, Milwaukee, Wis., San Diego and Seattle, which all posted occupancy improvements of 60 or more basis points since the fourth quarter.
“Office demand is expected to outpace new supply in the next two years, further tightening the vacancy rate and keeping rent growth above inflation in a majority of the U.S. markets,” Havsy said.
CBRE expects the U.S. office market to improve in 2016, he noted, as the U.S. economy continues to expand and office space demand is driven up by more professional hiring. About 109,000 office jobs were added in the first quarter. “Demand for space remains healthy, fueled by steady job growth, and we expect the market to continue to strengthen at a modest pace for the remainder of the year,” Havsy said in the statement.