Heavy demand fills the office market to the brim

The once half-empty glass of the office market is now spilling over to the delight of owners and brokers. In the early-1990s, brokers and owners of office properties had to ask themselves the question of whether the glass (or office building) was half-empty or half-full. Considering the state of the market at that time, the answer was probably the former. But things have turned around quickly and, in 1997, the demand for office space has filled the glass to the rim.

"Demand and absorption have really accelerated in recent months, particularly during the first quarter," says Robert Bach, national director of market analysis at Grubb & Ellis, Chicago.

New York-based Cushman & Wakefield statistics indicate an overall national suburban vacancy rate of 12.5% at the end of the first quarter. The numbers show a 14% rate for CBDs.

"The CBDs are moving slower, but they are improving," says Kent Gregory, senior vice president with The Opus Group, Minnetonka, Minn.

The vacancy rate of many CBDs exceeded 20% just a few years ago, says Richard Gatto, senior vice president with The Alter Group, Chicago, underscoring the significant improvement.

"In general, the higher quality the building the tighter the space," explains Gary Beban, president of Los Angeles-based CB Commercial Real Estate and Madison Advisory Group.

"Some suburban markets have seen rents spiking $20 to $30 in six months time," says Gatto.

"These are the first bona fide rent spikes in 10 years," adds Phil Norwood, chief executive officer with Charlotte, N.C.-based Faison.

Rising rents prompt construction "But," adds Jim Nugent, vice president/leasing at Cali Realty Corp., Cranford, N.J., "financing is still more strict than in the past."

At the end of the first quarter, approximately 16 million sq. ft. of space was under way in the 31 markets surveyed by Grubb & Ellis, with more than 14.8 million sq. ft. of that in the suburbs.

"The suburbs have been the first markets to get vacancies down and rents up enough to justify new construction for speculative building," says Gregory.

Another 10.7 million sq. ft. of build-to-suit office space is under way nationally. Of that total, Grubb & Ellis reports, 2.6 million sq. ft. is in the CBD.

Overbuilding still a concern While some in the industry fear a return of overbuilding, others feel the motivation behind the capital in the current building push will prevent that from happening.

"The biggest change from the late-1980s, is that the dollars pursuing office development currently are return-driven not fee-driven," says Dick Schaller, executive vice president of CMD Realty Investors Inc., Chicago.

"Atlanta will be the bellwether for office development," says David H. Steinwedell, managing director for the Atlanta office of Cushman Realty Corp. "There is more new office construction here than any other market (4.2 million sq. ft., reports Grubb & Ellis). If this space is absorbed and the market survives, more new construction will probably start in other markets."

During the first quarter, Grubb & Ellis reports that more than 17 million sq. ft. was absorbed nationally. Cushman Realty's National Office Investment Report indicates absorption rates were either increasing or remaining the same in the larger markets of every region .

"There is a great momentum in the office sector nationally, and we see continuing velocity in both downtown and suburban markets," says Clive G. Mendelow, president of Binswanger Advisory Group, Philadelphia.

Success in the suburbs is what first attracted investors back to office product, and while this market remains the strongest, some think it may be at its peak. "There is a view that suburban may have topped out in some markets," says Mendelow.

In Chicago, Steve Stratton, managing principal with Tanguay-Burke-Stratton, says only two spaces of over 150,000 sq. ft. currently exist and five candidates are interested.

Just as suburban development may be reaching a peak, forcing interested parties downtown, Class-B office product is now the focus of many because of a lack of Class-A space.

"There is very little Class-A inventory left in any major markets," says Stratton.

As the Class-A and better Class-B space is either leased or sold in the larger markets, focus has naturally shifted to the next market level.

"Secondary cities certainly have some values," says Sally Gordon, national director, real estate research and economics with KPMG Peat Marwick LLP, New York.

While general trends provide a useful macroview of the office sector, each individual market has its own nuances that need to be factored.

Southeast The Southeast has been the leader in the office market resurgence thanks to tremendous job growth. Atlanta is expected to add 100,000 new jobs in 1997, which will help absorb the space being added to the suburban market. No construction is expected in the CBD.

Average Class-A rents in the suburbs at the end of the first quarter were $22.27 per sq. ft., according to Grubb & Ellis. Overall vacancy stood at 9.7%. In total, the market absorbed 1.3 million sq. ft.

In Washington, D.C., investor interest is the story. The top 10 office sales or price offerings were all in the Washington area, says Steinwedell.

Washington's rents are among the highest in the country at $27.98 per sq. ft. and $35 per sq. ft. for Class-A space. The market has a low vacancy rate of 7.6%, with 1.6 million sq. ft. of speculative development under way. It is the only CBD in the country with substantial speculative development.

Orlando, Fla., is also a strong market in the region. The city is one of the few where the CBD is healthier than the suburbs. Cushman & Wakefield reports that vacancy in Orlando's CBD was 7.5% at the end of the first quarter and 11.2% in the suburbs.

Northeast After being mired in a colossal slump in the early-1990s, the Northeast seems poised to break out.

"Boston was in the tank five years ago, but now it is the hottest market around," says Mendelow. "Rents have jumped 20% since 1993."

Boston's rapid return coincided with that of the financial services business, which is a major local industry. The suburbs thrive on high-technology companies. Combined, the CBD and suburbs absorbed more than 1 million sq. ft. during the first quarter.

In New York, the downtown is still struggling with high-vacancy numbers (18.9%), but Midtown has seen vacancy drop below 10%.

In Philadelphia, the downtown is gaining strength as the amount of space for large users dwindles, says Mendelow.

Midwest The always steady Midwest has remained so in 1997.

In Chicago, Stratton says the office market has been absorbing about 10 million sq. ft. per year, and Class-A vacancy is in the 8% to 9% range.

Average rents declined slightly in the CBD but rose almost $1 in the suburbs, reports Cushman & Wakefield.

Grubb & Ellis reports that half a million sq. ft. of speculative construction was under way at the end of the first quarter. All of it is in the suburbs. However, Stratton believes the CBD may be on the verge of a new office project.

Minneapolis is still seeing a lot of office demand from medium-sized companies that are benefiting from the good labor force.

The CBD recovered before the suburbs in Minneapolis, and that is reflected in the rents. Class-A office in the CBD is bringing $26.50 per sq. ft., while suburban Class-A is bringing only $25 per sq. ft.

In Detroit, more than 1 million sq. ft. of office tenants have been displaced by General Motors' purchase of Renaissance Center, and developers are scurrying to put together new projects. "We should hear a few announcements of new office space before the end of the year," says Mark Cleary with Plant & Moran CRESA, Southfield, Mich.

This should further help Detroit's CBD, which saw vacancy drop almost 4% in the 12 months ending with the first quarter, although it still stood at 20%, according to Cushman & Wakefield.

St. Louis is another Midwest market with an improving CBD, and suburban vacancy is under 10%.

Southwest Despite CBD vacancy rates among the highest in the country at well over 30%, the Dallas suburban market is "one of the hottest in the country," says Maria Sicola, managing director of research services with Cushman & Wakefield. Suburban vacancy at the end of the first quarter stood at 9.6%, and average rents have moved above $20 per sq. ft.

But there is some good news for downtown Dallas. It experienced its first period of positive absorption (270,000 sq. ft.) in six years, during the first quarter. As a result, rents have improved about 15%. In addition, the CBD has been the recipient of two corporate relocations. TransAmerica has moved into 150,000 sq. ft., and Blockbuster Entertainment has moved its headquarters into approximately 250,000 sq. ft.

Denver has been a very hot market in recent years with vacancy dropping in both the suburbs and the CBD, the latter experiencing a 3% drop in the past year to 12%, according to Cushman & Wakefield. The suburban rate is at 10%.

Grubb & Ellis reports that more than 1 million sq. ft. of speculative office space was under way in Denver at the end of the first quarter, with most of it in the suburbs.

Cushman & Wakefield reports that Class-A rents have leveled off over the past year. Downtown the rent average is $16.59 per sq. ft. The suburbs showed a small increase to $19.14 per sq. ft.

The market experienced almost 400,000 sq. ft. of absorption during the first quarter, reports Grubb & Ellis. This follows up on last year's 860,000 sq. ft. of absorption, reported by Corporate Real Estate Service Advisors' (CRESA) 1997 Tenant's Guide to North American Markets.

According to CRESA, Austin's office vacancy stood at 9% at the first of the year, despite the addition of 400,000 sq. ft. of new office space in 1996.

West Out west, San Francisco is leading the way. During the past year, it experienced an increase in average Class-A rent of $7.73 per sq. ft. in the suburbs, raising rents to $31.42 per sq. ft., and a $5.67 per sq. ft. increase in downtown, bringing its average to $25.94 per sq. ft., reports Cushman & Wakefield.

"City restrictions on the amount of building helped keep San Francisco from an oversupply in the 1980s," says Beban. As a result, the rise in demand had pushed vacancy down to just 6.6% in the CBD and 8.8% in the suburbs.

The Los Angeles CBD, which was considered one of the worst office markets in the country the last few years, is now recovering, albeit slowly, across the board. Submarket vacancy rates are on the decline.

In Phoenix, the office market remains healthy with a suburban vacancy rate of 9% and a CBD rate of 15.9%. Phoenix had more than 1 million sq. ft. of office under way at the end of March, according to Grubb & Ellis.

Seattle maintains one of the nation's lowest overall vacancy rates at 4.9%. The CBD, where average Class-A rental rates now top $20 per sq. ft., is outpacing the suburbs by more than $5.

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