U.S. Office Markets Continued to Tighten in Q3, But at Slower Pace

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Slowing Absorption, Declining Vacancy and Rising Rent Characterized the Quarter
 
According to global real estate consultant Cushman and Wakefield, the U.S. office market continued to gradually tighten in the third quarter of 2016.
 
That tightening reflects the more moderate pace of job growth, which has slowed from the strong rate of the previous two years. Net absorption of office space totaled 13.2 million square feet ('msf') in the quarter, down from 17.9 msf in the second quarter. In the first three quarters of 2016, the amount of space absorbed totaled 42.2 msf, more than 31% lower than the 61.5 msf absorbed in the first three quarters of 2015.
 
The amount of space absorbed was still larger than the 11.3 msf of new office space completed across the U.S. during the third quarter and, as a result, the U.S. office vacancy rate continued to decline in the third quarter of 2016, dropping to 13.2% from 13.3% in the second quarter. It is the lowest national vacancy rate since the first quarter of 2008. Since reaching a peak in the first quarter of 2010, the national vacancy rate has fallen 420 basis points.
 
"From wild swings in the stock market early in the year to Brexit, Federal Reserve policy and now the upcoming election, U.S. companies have had a lot to digest this year," said Kevin Thorpe, Cushman & Wakefield Global Chief Economist. "Although they continue to expand, they are doing so more cautiously."
 
Job growth, the key demand driver for office markets, has downshifted during 2016 following the blistering pace of 2014/15. A slowdown is not unexpected at this stage of the cycle, as the economy approaches full employment and companies have a harder time finding qualified workers.
 
As absorption is slowing, the construction cycle is picking up momentum. At the end of the third quarter, slightly more than 103 msf of office space was under construction, the highest level for the construction pipeline in the current cycle. It could well be that 2017 will turn out to be the inflection point when new construction exceeds absorption, and national vacancy rates bottom out. Markets with the largest pipeline of office space are Midtown Manhattan, with 9.5 msf under construction, followed by Dallas/Fort Worth (7.7 msf), Silicon Valley (6.3 msf), Seattle (4.6 msf), Washington, DC (4.2 msf) and Northern Virginia (4.1 msf). Relative to the size of its inventory, the market with the largest pipeline of new construction is Nashville, TN, where the 3.7 msf of new construction represents 10.5% of the market's total inventory. Other markets where new construction represents a significant proportion of inventory include Brooklyn (7.2%), Seattle (7.5%), Puget Sound (5.3%) and San Francisco (4.8%).
 
The vacancy rate declined from the second to the third quarter in all major regions of the country (Northeast, Midwest, South and West). Markets with significant declines in vacancy during the quarter were North Bay San Francisco (-160 bps), Fort Lauderdale (-130 bps), Indianapolis (-130 bps), Tampa (-120 bps) and Puget Sound Eastside (-120 bps). At the other end of the spectrum, there were large increases in vacancy during the quarter in Tulsa (+130 bps) and Houston (+110 bps) as the softness of the oil sector continued to weigh on energy-centric markets.
 
For the most part, vacancy rates improved during the quarter. Of the 87 markets tracked by Cushman & Wakefield, the vacancy rate declined in 57 and only increased in 22--the others were unchanged. The lowest vacancy rate in the nation is in Nashville, TN, at 4.7%, followed by Midtown South in Manhattan (6.7%), Charleston, SC, (7.0%), San Mateo County, CA (7.5%), and San Francisco (7.7%). Many markets with very high vacancy rates are all or almost all suburban, such as Westchester County, NY (22.8%), Fairfield County, CT (21.5%), Suburban Virginia (21.1%) and Suburban Maryland (21.2%).
 
"There appears to be an emerging slowdown in tech markets across the U.S.," noted Ken McCarthy, Principal Economist and Applied Research Lead. "In 2015, the top 12 tech markets in the U.S. accounted for 35% of total absorption in the 87 markets tracked by Cushman & Wakefield. Thus far in 2016, these same markets have accounted for only 13% of absorption." Absorption was strongest during the first three quarters of the year in Dallas/Fort Worth (3.6 msf), Phoenix (2.8 msf) and Chicago (2.4 msf).
 
The national weighted average asking rent increased 1.4% from the second quarter and 5.5% from a year earlier to an all-time high of $29.45. Since reaching a bottom in mid-2011, average asking rent has increased 19.8%. In the third quarter, the fastest rent growth was in the Northeast region where average asking rents rose 2.3%, followed closely by the West region's 1.5% increase. Large increases in Brooklyn, Manhattan and Boston were responsible for the average rent growth in the Northeast, while in the West it was San Francisco, Orange County and Seattle that helped to pull rents up. In all, rents increased during the quarter in 56 of the 87 markets tracked by Cushman & Wakefield while declining in 25.
 
The most expensive markets in the U.S. were dominated by Manhattan and San Francisco. Midtown Manhattan retained its position as the most expensive market, with average asking rent of $79.91 per square foot. Midtown South had the second-highest rent at $70.29. San Francisco ($69.21), Downtown ($59.13) and San Mateo County at $56.55 rounded out the top five. Number six was Washington, DC, at $51.93. For the second consecutive quarter there were six markets with average asking rents above $50 per square foot.
 
Rent growth was generally strongest in the markets with low vacancy. Compared to a year ago, asking rents rose strongly in Brooklyn (14.5%), San Francisco North Bay (+13.9%), Dallas/Fort Worth (+13.2%), San Mateo County (+11.9%), and Silicon Valley (+11.0%). Not surprisingly, many high-vacancy markets experienced declines in rents compared to a year ago, including Suburban Virginia (-4.0%), Pittsburgh (-2.9%) and Fairfield County, CT (-2.8%).