U.S. Office Market Sees 3Q Absorption Rates Eclipse 2010 Levels by 75%, High-Tech and Energy Driving Demand

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According to Jones Lang LaSalle's Third Quarter 2011 United States Office Outlook Report, the U.S. office market absorbed approximately 9.4 million square feet of space in the third quarter of 2011, bringing the year-to-date total to more than 24.5 million square feet, eclipsing 2010 levels by more than 75 percent.  While vacancy levels continue to decline, the lack of job creation could spell a future slowdown in occupancy growth as average job gains have decreased to less than 40,000 jobs created per month since April 2011.

Third-quarter office performance highlights

• Vacancy levels continue to decline, falling 30 basis points to 17.8 percent in the third quarter; representing the first time vacancy dipped below 18 percent since the second quarter of 2009

• Absorption gains and momentum continue to be driven by industry segments and geographies with high-tech and energy companies. The Western half of the country has seen the dominant amount of absorption

• Third-quarter 2011 leasing activity levels have fallen 12 percent compared with 2010 third-quarter leasing activity

• Rents continue to increase marginally; however, concessions also have ticked upwards for the first time in several years, illustrating that landlords are increasingly trying to lure tenants

"We are starting to see a lag develop between office market performance and the current economic volatility," said John Sikaitis, Director of Office Research, Jones Lang LaSalle.  "We typically see transactions slow during the summer months; however, this slowdown in leasing volume was compounded by the declining confidence levels of senior executives who have once again put hiring and growth plans on the sidelines."

Stable rents

Overall, rents across the United States remained stable over the course of the third quarter, inching up approximately 30 cents per square foot to $27.74 per square foot. The pricing growth realized during the quarter was largely driven by more substantial rent increases in only a few markets rather than movement across all markets. The San Francisco Peninsula, San Francisco, San Antonio, Miami, New York, Philadelphia and Austin markets displayed the largest quarter- over-quarter rental increases, with the San Francisco Peninsula and San Francisco markets commanding premiums greater than 3 percent compared to the second-quarter 2011 averages due to a continued increase in technology demand.

In contrast, the industrial Midwest markets of Detroit, Cleveland and Cincinnati, along with the Sunbelt markets of Phoenix, Jacksonville and Tampa Bay, displayed the largest declines over the quarter. Each market demonstrated rents moving downward at rates greater than 1 percent for the quarter.

"The increased uncertainty in the global economy, combined with smaller amounts of near-term lease rolls due to 'blend and extend' leases undertaken in 2010, have pushed leasing activity levels down substantially from prior periods," said Sikaitis. "While we continue to see positive absorption overall, only select markets are seeing real rental rate increases."

Markets driving demand

The Western half of the country, specifically Texas, Denver and the West Coast tech-heavy markets, continue to dominate gains in the market based on the strong regional economies driven by energy and technology. While overall leasing activity nationally was down 26 percent in third-quarter 2011 versus third-quarter 2010, the energy and technology market segments accounted for approximately 42.5 percent of occupancy gains despite the fact that both comprise just 20.7 percent of supply.

The Texas markets of Austin, Dallas, Houston and San Antonio accounted for 17.3 percent of occupancy gains year to date, or 4.1 million square feet. Denver, which is driven by both tech and energy, has absorbed 1.2 million square feet throughout the year, with 414,054 square feet in the third quarter.  The West Coast tech markets of San Francisco, San Francisco Peninsula, Silicon Valley and Seattle generated the most occupancy gains to date with 4.8 million square feet or 20.1 percent.

"Consumer demand for gadgets, apps and new forms of media, coupled with businesses' technological needs, are what's driving high-tech employment," said Colin Yasukochi, San Francisco-based Director of Research for Jones Lang LaSalle's Northwest Region. "Employment in the high-tech sector is a bright spot in an otherwise gray economic picture. While not strong enough to uplift the entire national economy, high-tech strength is impacting office markets across the country with San Francisco, Silicon Valley and Baltimore experiencing the strongest growth."

Although no new developments were announced or started during the third quarter, the lack of development - less than 7 million square feet or 0.5 percent nationwide - is actually a boon for landlords as this aids in net absorption. "Large users of 150,000 square feet or more are going to find it increasingly difficult to find space in the coming years.  We expect spec development to be announced in tightening and high-demand markets such as Houston or the Silicon Valley in 2012," added Sikaitis.

Houston

The Houston office market is showing impressive growth signs with sustained to increased activity backed by a diversified, stable economy. Houston is one of the top performing office markets in the country, mainly a result of the economic livelihood and energy focus of the area. Houston's economy is doing well in spite of the depressed national economy, with employment figures increasing, especially for high-paying industries. Growth is occurring from existing energy-related firms such as BP and Plains All American, LLP. Firms such as Nexen Petroleum U.S.A. are also opting to relocate to Houston due to its stellar economy, global oil and gas presence, and excellent quality of life.  Sales activity has nearly doubled, leasing activity remains robust, and positive absorption is anticipated to increase. Tenants remain active and continue to canvass the Houston market for high quality spaces. Until new buildings are delivered, and as quality availabilities diminish, concessions will continue to dry up and effective rates will increase in Houston's strongest submarkets.

New York

The summer months are typically the slowest for the Manhattan office market and this year proved to be no exception.  Coming off a robust second quarter, market indicators in the third quarter pointed to a period of flattening. Vacancy rates slowly improved and absorption, while positive, was off considerably from the second quarter.  Meanwhile, average asking rents rose on the strength of the trophy market.  Wide disparities in rents exist within the market depending on geographical location and position within a building. Investment sales activity thus far in 2011 has remained strong. Though uncertainties in the debt markets and slowing economic growth have impacted investors' view of office market fundamentals, the impact has been less in New York City than in most of the country. Transaction volume has rebounded strongly and pricing has returned to near-peak levels.

San Francisco

Strong demand is lifting market rents to highs last seen in 2007, with the overall rate increasing by 22 percent year over year, the fastest rise in the nation by far.  High-technology tenants are driving demand and currently represent more than 40 percent of new space requirements, which has led to 1.5 million square feet of net absorption during the past 12 months.  Several expansions during the quarter drove the vacancy rate down to 15.6 percent.  In the high-tech haven South of Market (SOMA) submarket, vacancy has dipped to 5.7 percent. Tighter market conditions are expected in conjunction with higher rents over the near term, although both are expected to slow from current trajectories as the years ahead bring additional supply to the market.

Silicon Valley

Economic performance in the Silicon Valley, driven by the tech industry, remains robust while much of the nation still struggles with weak growth prospects. For the third quarter in a row, Silicon Valley has been ablaze with activity as the demand for quality office space continues to drive the market. With current conditions tightening, highly desired areas like Palo Alto and Mountain View have become increasingly unattainable for large tenants in the market, pushing activity towards Santa Clara and North San Jose.

Washington, D.C.

The economic outlook in the Metro D.C. region darkened at the end of the third quarter as the region suffered three consecutive months of job losses and a divided Congress stalled the passage of new legislation. A push for austerity and an increasingly divisive political climate threatened to interrupt future levels of federal spending for contractors and other private sector businesses.  As a result, tenants became more careful and judicious in regard to hiring, business planning and real estate decision-making.

The home stretch

Sikaitis adds, "A lack of confidence has started to form a cloud over various segments of the office market. Although office employment levels remain positive and higher than overall employment growth rates, business and CEO confidence measures have declined in recent weeks, meaning near-term hiring (notwithstanding the tech and energy industries) is likely to be limited and office demand is likely to be lower in 2012. As a result, we expect the fourth quarter of 2011 to have positive momentum and to close the year ahead of 2010; however, we predict rent levels across many segments of the market will remain quite level, and we expect an even slower recovery over the short term due to this heightened state of uncertainty."

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