Office Space Net Absorption in U.S. Slows in 2Q, Says Reis Report

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Based on a new office market report from Manhattan-based Reis, Inc., 2Q-2011 marks the third consecutive quarterly increase in occupied space following 11 consecutive quarters of decreases.

However, net absorption of 3.7 million square feet was below the first quarter's net absorption of 5.5 million square feet. This slowdown was largely reflective of changes that are taking place in the macroeconomy.

Real GDP growth slowed down during the first quarter after accelerating for two consecutive quarters. Moreover, labor market data from the Bureau of Labor Statistics has shown a slowdown in hiring in May after a brief period of acceleration earlier this year. It appears as if these developments caused firms to act a bit cautiously regarding their leasing and space requirements during the second quarter.

Report Highlights:

• 2Q 2011 Net Absorption: 3.7M square feet

• 2Q 2011 Vacancy Rate Change: 0 bps, from 17.5% to 17.5%

• 2Q 2011 Asking Rent Change: +0.2%

• One-Year Asking Rent Change (2Q2010 to 2Q2011): +0.7%

• 2Q 2011 Effective Rent Change: +0.2%

• One-Year Effective Rent Change (2Q2010 to 2Q2011): +0.8%

"Nonetheless, we remain cautiously optimistic about the recovery in both the economy and the office market. Many of the factors that caused the economy to slow during the first half of this year, such as a dramatic and unanticipated increase in energy prices, a snow-filled winter for a large portion of the country, and the disruption caused by the twin disasters in Japan, are isolated incidents that are likely to have only a temporary impact" said Reis senior economist Ryan Severino. 

Severino further stated, "Although the recent slowdown in economic activity has resulted in downward revisions to the forecast for real GDP growth by both the Federal Reserve and the market consensus, the overall economy should continue on its current path of expansion, and we expect that rents and vacancies will continue to improve in 2011. However, as the recent slowdown indicates, our outlook is not without concerns.

"The global economy is riddled with potential pitfalls. The state of finances in Europe has not improved, geopolitical risk, particularly in the Middle East and north Africa remains a concern, the weight on the global economy of the devastation in Japan, though temporary, is of indefinite length, and inflation continues to edge higher. All of these present risks that could negatively impact the economy and office market in 2011."

With the economy hitting a rough patch and credit conditions still tight, completions decreased during the quarter, with 1.8 million square feet of office space coming online.  This set a new record for the lowest level of completions since Reis began publishing quarterly data in 1999.  This quarter's record-low level of completions was only marginally surpassed by positive net absorption of 3.7 million square feet, which caused vacancy to remain unchanged from the first quarter of 2011 at 17.5%. On a year-over year basis (from 2010Q2 to 2011Q2), vacancy increased by 10 basis points.

Rental Rates

During the second quarter of 2011 we observed the third consecutive quarter of asking and effective rent increases. Asking rents had been falling since peaking in the third quarter of 2008 while effective rents had been falling since peaking in the second quarter of 2008, before beginning to rise in the fourth quarter of 2010.

However, the rate of increase decelerated versus the first quarter as both asking and effective rents increased at a slower pace than last quarter when both rose by 0.5%. Nonetheless, the increase in asking rent continues to be a positive development and demonstrates that despite recent changes in the economy, landlords remain confident enough about their prospects to move beyond adjusting concessions and continue to increase face-level asking rents, albeit slightly. Effective rents are generally keeping pace with asking rents, indicating little, if any, change in concessions during the quarter.

Severino  further commented, "Although we expect the economy and labor markets to continue to improve and we have not altered our outlook for the office market, recent developments in the economy serve as a stark reminder that this will be a protracted and inconsistent recovery in the office market.

"The office vacancy rate increased in 23 of the 79 primary metropolitan areas; effective rents fell in 22 out of 79 markets (down from 34 in the first quarter of 2011); the decrease in the number of markets with falling effective rents reinforces the notion that landlord sentiment continues to improve, expanding to a greater number of markets."

MSA Level Trends

Vacancies were flat during the second quarter for New York office properties while effective rents generated a positive 0.6% increase. This is the fourth consecutive quarter with positive effective rent growth.  Washington DC maintains its status as Reis's tightest market, with DC sporting the nation's lowest vacancy rate of 9.0%, benefitting from its unique position as the nation's capital.

At the other end of the spectrum remains Detroit, with a vacancy rate of 26.7%, the highest among primary metropolitan areas. Detroit is still grappling with issues in the manufacturing sector, particularly in the auto industry, causing its office market to struggle.

The decrease in the number of markets that registered quarterly effective rent declines (22 out of 79 this quarter, versus 34 out of 79 in the first quarter of 2011), indicates that we are not only seeing an improvement in the aggregate data at a national level, but that renewed leasing activity continues to spread across different metro areas.

"As further evidence of the positive changes that took place during the second quarter, year-over-year figures for effective rent change show that for the most distressed MSAs, even though effective rents are not yet increasing, the rate of decline continues to slow. San Francisco now boasts the highest year-over-year effective rent change, at 6.0%", concluded Severino.

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