Office Fundamentals Continue to Crumble

Climbing vacancies and a sluggish leasing market continue to dog the national office market. The national vacancy rate for CBDs registered 14.4% in the third quarter of 2002, up from 14.1% in the second quarter, reports Cushman & Wakefield. A year ago, the vacancy rate stood at 10.6%.

The worst may not be over, according to Maria Sicola, senior managing director of research for the New York-based firm. Weak job growth, ongoing corporate scandals and the looming conflict in the Middle East threaten to dampen prospects for full recovery until at least 2004, she says. “If we stay with positive employment growth and don't have any extenuating circumstances that cause the bottom to fall out of the market, we'll start to slowly see a turnaround by the end of next year, but we won't start to see anything dramatic until 2004,” she predicts.

Jay Spivey, director of analytics for Bethesda, Md.-based information services provider CoStar Group Inc. predicts another spike in vacancy rates before the turnaround. “I think we're heading toward a vacancy rate up to 18% before it's all over with,” he says. And recovery will be slow: “The commercial real estate market is a huge market,” he says. “It's like trying to stop a train.”

CoStar estimated a 14.7% vacancy rate for all metro area classes of space in the third quarter, up from 14.3% in the second quarter. And it figures that average rents dropped to $22.82 per sq. ft. in the third quarter, down from $23.23 in the second quarter. “It's not like recovery happens overnight,” Spivey says. “In the last real estate cycle we hit bottom around '90 or '91. So if that's the bottom of the market, and the top of the market wasn't until 2000, that's nine years.”

While the leasing market has been soft, the investment sales market has been hot, due primarily to low interest rates and a wave of capital that has fled the volatile stock market for the safety of real estate. New York research firm Real Capital Analytics reports buyers have signed $32.1 billion in deals since the beginning of 2002, compared with $24 billion in the same period last year.

Declining sublease space provides a glimmer of hope. Cushman reports that sublease space in the third quarter declined for the first time since the fourth quarter of 2000. Total sublease space available now is 122.7 million sq. ft., down slightly from 126.2 million sq. ft. in the second quarter.

But that's little consolation. Until employment, especially white-collar employment, picks up, the outlook will continue to be gloomy for landlords, Sicola predicts. The unemployment rate has shown some signs of improvement, dropping from 5.9% in the second quarter to 5.7% in the third quarter, according to the Bureau of Labor Statistics.

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