Commercial Investment Real Estate September/October 2013 - Page 31

THE NUMBERS: A SLOW RECOVERY CONTINUES With the labor market unable to generate sig- by Brad Doremus and Victor Calanog nifi cant offi ce- using employ- ment, demand for offi ce space remains muted. The vacancy as unchanged during second quarter 2013 rate wa was 17 0 percent, pe at 17.0 a slight slowdown from the prior quarter’s 10 basis point decline. The pace of the offi ce sector’s recovery has been very weak: On a year-over-year basis, the vacancy rate fell by just 30 bps. It is therefore unsurprising that national vacancies have declined only marginally since peaking at 17.6 percent in late 2010. National vacancies remain elevated at 450 bps above the sector’s cyclical low, recorded in the 3Q07 before the recession began that December. Occupied stock increased by 7.2 million square feet in 2Q13. Much of this increase stemmed from the 7.6 million sf of offi ce space that came online. Without this construction-driven absorption, same-store absorption fi gures indicate that there is little to no demand for space in existing build- ings. At this point in the recovery, rental rates are still compressed across new versus existing space; combined with aggressive concession packages, tenants will tend to favor new buildings. While comparatively modest by historical stan- dards, having inventory increase by 7.6 million sf does support the notion of supply growth trend- ing toward a more normal rate. The market has not delivered as much new space since the 2Q10 when many projects were completed only because they had been started before anyone fully grasped the magnitude of the Great Recession. Auspi- ciously, 2Q13’s increase in construction activity comes hot on the heels of last quarter’s 2.2 million sf of new offi ce space, the lowest quarterly fi gure for new completions since Reis began publishing quarterly data in 1999. Most of the new space coming to market is signifi cantly pre-leased, as is required for most developers to acquire fi nancing in the current offi ce property environment. Asking and effective rents both grew by 0.4 percent during 2Q13. This increase is about par for the course since rents began rising consistently in 4Q10. Rents have now risen for 11 consecu- tive quarters, yet the cumulative growth for asking and effective rents during this recovery period is only 4.7 percent and 5.4 percent, respectively. For comparison’s sake, the offi ce market is able to pro- duce that kind of rent growth in typical calendar- year periods. Rents remain below peak levels set in 2008, and without stronger gross domestic prod- uct growth and more robust job creation fi gures, it will take years to return to those levels. Looking Forward We remain cautious about the remainder of 2013. There is some optimism given the underlying resurgence in the economy that the labor mar- ket will not experience the midyear swoon that we have seen in the last few years. However, the headwinds from fi scal policy due to both increased taxes and sequestration have been putting the brakes on the labor market recovery in recent months: Year-to-date job growth is actually running behind the comparable period from 2012. Economic activity outside of the U.S. will not provide a panacea in the short term. Slowing economic expansion in Asia, particularly China, is expected to continue to exert a drag on worldwide economic growth. Near-term relief from European markets is also not expected as many Western and Central European economies are still struggling with the combined impact of high unemployment, bad debt, and the ramifi cations of their govern- ment austerity programs. These headwinds are likely to persist until at least late this year as the economy fully digests domestic fi scal policy changes and subpar economic activity outside our borders. With full sequestration initiated this quarter, married with higher taxes from the fi rst quarter and the specter of higher interest rates for the remainder of the year, job growth for 2013 is now expected to be slightly below 2012. We expect offi ce vacancies to descend very slowly, ending the year at just below 17.0 percent, and asking and effective rent growth to be below 3.0 percent. Brad Doremus is senior analyst and Victor Calanog is head of research and economics for New York-based research fi rm Reis. September | October | 2013 29