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Office Absorption Rises, But Concerns Persist

With so much hoopla over the hot investment sales market and the lofty prices office buildings are commanding, it's easy to overlook trends in the underlying real estate fundamentals. News of a record-breaking sale price is more dramatic than quarterly changes in vacancy, net absorption and rents. But these metrics offer a snapshot of the state of the industry, even if they can't predict the future.

The good news is that net absorption — the change in occupied space from one quarter to the next — is on a roll. Net absorption in the second quarter totaled nearly 25 million sq. ft., the highest figure since the second quarter of 2000 when 34.4 million sq. ft. of space was absorbed, according to Grubb & Ellis. To put that in perspective, the office market experienced nine straight quarters of negative absorption beginning in the first quarter of 2001 and continuing through the first quarter of 2003. It was a painful period in which analysts underestimated the depth of the office leasing market downturn. The 17.9% vacancy rate notched in the second quarter of 2003 was just shy of the high mark of 18% set in the third quarter of 1991. Today, the vacancy rate is 15.6%, still unhealthy but an improvement of 80 basis points over the first quarter.

What accounts for the strong absorption? “Job growth overall has been up one quarter and down the next, but the key sectors that generate demand for office space have been healthy,” says Bob Bach, national director of market analysis for Grubb & Ellis. The three office-using sectors — professional and business services, information, and financial activities — have added 334,000 net new jobs through June 2005 and 646,000 jobs over the past 12 months.

Rental rates also are on the rise. Asking rents for Class-A space averaged $29.19 in the second quarter, up 5% over last year. That's still far below the average asking rent of $35.43 reached in the fourth quarter of 2000, near the peak of the dot-com boom.

Still, corporate layoffs remain a concern, even as the economy is on its way to generating 2 million jobs this year. Nearly 200,000 job cuts were announced during May and June. Then in July, Hewlett-Packard announced it would reduce its workforce by 14,500 over the next six quarters, with the majority of staff reductions occurring in information technology, human resources and finance — white-collar jobs to be sure.

“What is particularly worrisome is that job cuts are not confined to a small number of sectors, but are coming from a wide of array of industries, including manufacturing, automotive, consumer products, retail and government,” says John Challenger, CEO of Challenger, Gray and Christmas, which has been tracking corporate layoffs since 1989. In cities such as Denver, where there has been significant downsizing in the technology and telecom sectors, concerns are rising about a possible erosion of housing prices, according to Challenger.

The bottom line is that while the office market has dug itself out of a deep hole, it isn't out of the woods just yet. Investors willing to gamble and buy vacancy in anticipation of a swift recovery are advised to proceed with caution.

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