It Could Be a Long Slog for the U.S. Office Market

In a classic 1980s TV ad promoting Wendy's, a little old lady standing at a competitor's store counter gazes at a mostly empty hamburger bun and asks, “Where's the beef?” Today's office owners are asking, “Where are the jobs?”

The economy lost 8.75 million jobs from February 2008 to February 2010, according to the Bureau of Labor Statistics, and has since regained 909,000 jobs, about 200,000 less than the previous estimate. If the U.S. economy were to generate 100,000 jobs monthly, it would still take us seven years just to get back to the previous employment peak.

The U.S. office vacancy rate for all classes of space stood at 17.7% at the end of 2010, down from 17.9% in the second quarter, reports Grubb & Ellis. That's just a tiny bit below the record-high vacancy rate of 18% reached in the fourth quarter of 1990 during the savings and loan crisis.

While New York and Washington, D.C. are proving to be resilient in the current cycle, they are among the exceptions. The office vacancy rate for all classes of space in metro Chicago in the fourth quarter was 20.8%, reports Grubb & Ellis. The Class-A vacancy rate in Atlanta's Buckhead submarket was nearly 30%. Buckhead alone had 3.5 million sq. ft. of Class-A space available at the end of 2010.

Negative sentiment

A NREI survey of lenders indicates 13% believe downtown office provides the best investment opportunities today. Only 7% of lenders indicate suburban office space offers the best investment opportunities. Conversely, a whopping 75% say that apartments hold the best investment prospects.

During last month's Mortgage Bankers Association convention in San Diego, NREI convened a panel of lenders to address several timely issues, including the plight of the office sector (see page 43). E.J. Burke, executive vice president of KeyCorp, hit the nail on the head when he said that aside from weak job growth, “the longer-term, more troubling trend is that most corporate users are using far less square footage per employee than they've traditionally done.” KeyCorp's long-term plan is to whittle down the average space per worker from 360 sq. ft. to 180 sq. ft.

Much ado about nothing?

There is a consensus among brokers that telecommuting has had a negligible effect on the demand for office space, which surprises me. I know of several people who work from home who didn't three years ago. Paul Lundstedt, executive vice president of the institutional capital markets group at Grubb & Ellis, says brokers first grappled with the telecommuting issue in the late 1990s and early 2000s.

“We were all afraid that people were going to send their employees home and work from home,” recalls Lundstedt, who is based in suburban Chicago. “Technology was improving, and this virtual work environment could take place. Most people have come to the conclusion that you need community, you need contact, you need to be working together collaboratively to make it successful and productive.”

Of more concern to Lundstedt is shadow vacancy. The veteran broker says many corporations have space under lease that they are underutilizing. “They can add employees before ever having to sign additional space.”

Lundstedt routinely conducts walk-throughs of office buildings that Grubb & Ellis is either marketing or that owners are considering selling. “You walk the space and you see that the body count is down. I think that has the potential of causing this recovery to take even longer.”

Demand for space will eventually return and possibly a lot faster than people anticipate, Lundstedt is convinced. That is what occurred in the early 1990s. At the time, Lundstedt was hearing dire predictions about the future of the office market. “People were talking back then about eight years of supply, that there is not going to be any rent growth, and that we're in for catastrophic problems,” recalls Lundstedt.

Make no mistake about it, there will be talk of gloom and doom this time as well until our economy shows us the beef in the form of healthy and sustainable job growth.

Contact Editor Matt Valley at [email protected].

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