Office sector sees regional gains, stagnant vacancy rate

Demand for new, high-end office space is outpacing construction.

Commercial real estate companies are seeing a modest recovery in the office segment as businesses ramp up hiring and transaction activity. However, a demand for new space has kept vacancy rates stagnant.

According to data from Cassidy Turley, the office sector is experiencing its third strongest quarter since 2010 as approximately 15.1 million square feet of office space was absorbed – about 10 million square feet (msf) more than in the first quarter.

"Even though there is a general push for space efficiency across most markets, business growth has been strong enough to generate consistent improvement in the office-leasing fundamentals," said Kevin Thorpe, chief economist at Cassidy Turley. "The demand metrics continue to be the strongest at the high end (Class A) and the low end (Class C) of the market, while the middle segment of the market continues to struggle to retain existing tenants or find new ones."

Regional improvements
New York lead the top 10 markets with the strongest demand for office space, with 1.7 msf of net absorption. Following just behind were San Jose, Houston and Atlanta. Regions showing healthy but moderate absorption included Chicago, Oakland, Omaha, Northern and Central New Jersey, the data stated.

However, market demand did not correlate strongly with rent growth, the exceptions being New York and San Jose which saw a year-over-year rental appreciation of 9 and 8.5 percent. Demand for new spaces could be a contributing factor regarding rent growth. 

"It is interesting to observe that tenants are consistently gravitating to newer buildings, and yet, that segment remains supply constrained," says Thorpe. "New development remains 30 percent below the norm. So this one sliver of the market, new space, is entering into a tight supply/strong demand scenario. Rents could very well soar for the new office space that delivers to the market over the next 12-24 months."

New office construction in the first quarter reached 7.59 million square feet – the most new space added to the market in nearly three years. Net absorption of new space, however, hit 7.23 msf, virtually wiping out any gains in new space, according to Reis, Inc. data.

Ryan Severino, senior economist for Reis, noted that even modest demand would not accelerate a decline in the national vacancy rate, which has been hovering between 17 and 17.6 percent. It is currently 17 percent. However, Cassidy Turley reports a decline of 10 basis points in the vacancy rate, falling to 15.3 percent. The discrepancy in the Turley data could stem from its reliance on data from 82 metros.

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