NREI Research Series

Part 3: Development and Leasing Outlook

Survey respondents said the level of development is about right for the sector, with only some fearing that too much space is being built. In this year’s survey, 53.6 percent said the level of development is the right amount. An additional 10.1 percent said there is too little development occurring.  However, 21.7 percent said too much development is taking place, with the remaining respondents saying they are unsure.

When asked to estimate how much additional supply their market could absorb, 29.8 percent said their markets could absorb less than 5 percent of current inventory. Another 30.5 percent answered “5 percent to 9 percent” and 22.1 percent said “10 percent to 14 percent.”

A Marcus & Millichap 2017 US Office Investment Forecast reported that 82 million sq. ft. of new office space will be delivered nationally in 2017, the peak for new office construction in the current cycle.

Outlook for occupancies remained virtually identical to our previous surveys. The majority of respondents (65 percent) said they expect occupancy rates to rise in their region in the next 12 months. That was the same figure as in 2016. However, about one-fifth, or 23 percent, said they think occupancy rates will decline (vs. 22 percent in 2016). And about 12 percent said they will remain flat compared to 13 percent last year. The 2015 figures were 66 percent for increase, 11 percent for no change and 21 percent for decrease.

But one trend in play is that technology firms are seeking shorter leases in a number of markets, according to Andrea Cross, head of Americas office research for commercial services firm CBRE.

“We are seeing this in Seattle and Boston. In San Francisco the amount of subleasing up-ticked in 2016, as tenants sought to take those box spaces at shorter lease terms—it’s plug and play,” she notes. But this year the amount of space available has declined, she adds.

Pushing for shorter lease terms is becoming commonplace in San Francisco. “Growing technology tenants desire shorter, more flexible lease terms, usually two to four years, to coincide with their funding raises—and thus headcount additions,” says Peter Conte, vice president in the San Francisco office of real estate services firm Transwestern. Meanwhile, landlords still prefer standardized five- to 10-year terms, Conte notes,—largely due to the methodology of underwriting buildings from an acquisition and financing model, which typically puts tenants’ and landlords’ interests in opposition.

“The problem is that while growing technology tenants would prefer short-term leases, and even if landlords wanted to concede term length, the historic highs of rental rates, coupled with the increased regulation and costs of construction, mean that the dollar outlay cannot be amortized over lease terms that are so short. This has forced leases to be longer terms, especially for particularly creative and expensive build-outs,” Conte says.

The picture was similar on rents. Respondents remain bullish, but the sentiment has begun to shift slightly. Overall, just less than three-fourths of respondents (73 percent) expect rents to rise in the next 12 months, while only 16 percent expect them to decrease. The figures have fallen in our successive surveys. In 2015, 83 percent said they expected rents to rise and only nine percent said they expected them to fall. In 2016, 77 percent said rents would rise and 14 percent said they would decrease.

Rents remained strong in the top U.S. office markets in the fourth quarter, with half of the markets tracked by Colliers continuing to see growth in rates. However, a cyclical slowdown is expected, with more than half of U.S. markets experiencing an increase in vacancy.

Vacancy is not expected to rise rapidly, but with an estimated 110 million sq. ft. of new office space under construction nationally, demand may not be able keep pace with deliveries in 2017, according to the Colliers report. But with the construction pipeline heavily front-loaded, deliveries will likely ease by 2018.

This year will likely be the peak in the cycle for the delivery of new office projects, according to CoStar Portfolio Strategy forecasts. The U.S. office vacancy rate has continued to steadily decline, moving from 10.7 percent in 2015 to 10.4 percent in 2016. CoStar forecasts a 55 percent spike in construction deliveries, increasing from 58 million sq. ft. of new office space in 2016 to over 90 million sq. ft. this year.

The 2017 totals stem from a large number of office projects that were started in 2015. Overall, 129 million sq. ft. of new office space started construction in 2015, according to CoStar. n

Research Methodology:

The NREI research report on the office real estate sector was completed via online surveys distributed to readers in March. The survey yielded 274 responses. Recipients were asked what regions they operated in (and were allowed to select multiple regions). Overall, 48.5 percent said they operated in the South, followed by the East (40.2 percent), Midwest (35.4 percent) and West (34.3 percent). Half of respondents (52.2 percent) hold the titles of owner, partner, president, chairman, CEO or CFO. Approximately half of respondents are investors or developers. The results from the current research were compared against prior studies completed in early 2016 and late 2015. The 2015 survey yielded 216 responses and the 2016 survey yielded 371 responses.

TAGS: Office News
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