On the Cusp of an Office Recovery?

The third quarter brought hope to the embattled national office market: Grubb & Ellis reports that the national office market vacancy rate has stabilized at about 18%, which could embolden landlords to cut back concessions in 2004. Before landlords start celebrating, however, they should consider a bloated inventory of direct, sublease and shadow space that will undoubtedly hamper any overnight recovery. And Grubb & Ellis believes that tenants will wield significant negotiating leverage well beyond 2004 and into 2005.

Net absorption also was positive during the second and third quarters of this year. The vacancy rate only climbed two basis points during the entire third quarter, with 25 of 45 markets posting vacancy declines. Twenty markets experienced vacancy increases.

There is a long-term demographic trend that could negatively impact the office market, according to Grubb & Ellis. The prime working-age population (defined as people between the ages of 25 and 54) will increase by only 2% this decade, which could cut the number of workers who occupy office buildings. As a result, Grubb & Ellis concludes that employees will have more leverage, possibly trading larger offices for more flexible work arrangements.

Despite three consecutive years of vacancy increases, investors aggressively sought after office properties during the third quarter. In fact, the General Motors building in midtown Manhattan this fall was sold for a record $1.4 billion, which translates into an astounding $778 per sq. ft. Industry sources are quick to label this an exceptional deal that is hardly emblematic of the entire market. But weak fundamentals really haven’t curtailed investor demand for office buildings.

Grubb & Ellis sees plenty of capital seeking office properties in 2004, with one caveat: some private investors may head to the sidelines if and when interest rates start to rise again. That could help institutional investors who have recently lost out to private investors in their quest to buy office buildings.

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