Strong Q1 Office Fundamentals Suggest ‘Market Still Has Room For Expansion’
Office leasing activity across the nation advanced in the first quarter, with tenants absorbing 5.2M SF, up from the negative 406K SF absorbed during the same period last year, Newmark Knight Frank reports.
Rents and vacancy rates in the 56 markets Newmark tracks remained stable, with average rents increasing modestly by 2.9% to $27.68 and vacancies inching down 10 basis points to 13.5% compared to the year-ago quarter.
"The national economy is expanding steadily, but the share of new jobs that is office-using is decelerating. As a result, the U.S. office leasing market is experiencing only modest growth," NKF Senior Managing Director of National Research Sandy Paul told Bisnow. "Office absorption strengthened during [the first quarter] compared with the same period in 2017, but softened compared with [the fourth quarter]. The vacancy rate is edging down and now stands at 13.5%."
Office demand across the country has rebounded this year after employers held off closing deals most of 2017 amid concerns over how President Donald Trump’s policies would impact the market. Newmark posits strong demand for new high-end supply and trophy assets will help absorb the more than 11M SF that was delivered during the first quarter.
New supply in the pipeline for this year now sits at 84.2M SF. Fears of an impending global trade war have stirred concerns about higher construction costs and builders’ ability to get future projects off the ground and completed on schedule, Newmark reports.
Absorption trailed deliveries this past quarter, and the trend will likely persist in markets where new offices under construction exceed existing product by 5%, such as the Silicon Valley; Seattle; Raleigh-Durham in North Carolina; and San Francisco.
“On the supply side, tighter lending standards appear to be keeping new supply generally in line with demand, lifting rents at a moderate pace,” Newmark reports. “Several markets are seeing bumps in construction, but others are seeing a thinning of their construction pipelines, as deliveries outpace starts. The overall balance between supply and demand suggests the market still has room for expansion.”
Winners and Losers
Washington, D.C., led the country in positive office absorption thanks to corporate relocations and expansions. Tenants in the District of Columbia absorbed 1.3M SF in the first three months of the year with deals inked by Nestlé (251K SF), Amazon Web Services (174K SF), Facebook (73K SF) and Yelp giving the market a much-needed boost, Newmark reports. Seattle trailed closely behind D.C. and was the only other market to absorb more than 1M SF in Q1. Seattle absorbed 1.2M SF last quarter, thanks to robust leasing activity driven by tech firms.
Employers in Hurricane Harvey-worn Houston are still overcoming real estate woes as a result of the storm, causing leasing activity to stall at the beginning of the year and occupancy levels to fall to negative 1M SF after rebounding in Q4 from a loss in the first three quarters of 2017. Manhattan office leasing also stalled in Q1, with negative 1.1M SF absorbed during the quarter — which Newmark attributes to four large properties that came online during the quarter — 55 East 52nd St., 135 West 50th St., 441 Ninth Ave. and 195 Broadway.
NKF Managing Director of National Research Stephanie Jennings said though there are concerns about excess space in the Big Apple, fundamentals there remain stable.
"New York is at full employment, the market has seen several noteworthy tenant expansions, availability is down from a year ago and rents have been stable over the last two years," she said.
Several factors indicate the cycle’s best years may be behind it, including slowing deal volume, fluctuating commercial property pricing that stands only 30 basis points above historic lows, plateaued cap rates, a widening divide between seller asking prices and buyer bids, and investors going in search of better returns in riskier, secondary and non-central business district markets.
Though the cycle is getting long in the tooth, the industry is expected to continue riding the waves of the strong economy to steady growth, albeit at a more moderate pace than in years past.
"During the balance of 2018, we expect net new demand for office space due to new hiring and a gradual plateauing of densification (the reduction of space leased per worker). However, headwinds include ongoing corporate consolidations, high concession levels and a pipeline that exceeds current demand," Paul said.