Occupancy Gains Stalled — But What’s New?
The national vacancy rate was unchanged during the fourth quarter at 16.9%. Unfortunately, given how slowly the office sector’s so-called recovery has progressed, this is not necessarily reason for worry.
Not since the third quarter of 2007 has the national vacancy rate declined by more than 10 basis points in any given quarter. For all of 2013, the vacancy rate fell by just 20 basis points, roughly comparable to the 30 basis point decline in 2012. National vacancies remain elevated at 440 basis points above the sector's cyclical low, recorded in the third quarter of 2007 before the recession began that December. Tepid supply growth and lackluster demand have remained largely in balance during this recovery, accounting for the slow pace of vacancy compression.
With most employment growth coming from low-paying, low-skilled jobs that do not utilize office space, demand remains weak. Occupied stock rose by 8.9 million SF in the fourth quarter. This is a meager increase from the 7.6 million SF that were absorbed during the third quarter. This was, however, largely due to a jump in completions. For the quarter, 9.3 million SF came online, up from last quarter's 6.3 million SF.
This dynamic between net absorption and construction held throughout the year. For 2013, quarterly net absorption averaged 7.1 million SF, a 69% increase from 2012's average of 4.2 million SF. For construction, the quarterly average was 6.5 million SF, a 109% increase from 2012's average of 3.1. Demand certainly increased in 2013, with office buildings entering the market mostly occupied (or leasing up quickly). This is in line with strict requirements for pre-leasing from lenders of construction and development financing.
The bottom line is that until the growth rate in high-wage, high-skill jobs that require office space accelerates, expect slack demand for existing inventory to be the norm and vacancy compression to be slow but steady.
Rent Growth Plods Along
Asking and effective rents both grew by 0.7% during the fourth quarter. Asking and effective rents have now risen for thirteen consecutive quarters. During 2013 the average asking rent increased by 2.1% while effective rent grew by 2.2%. This was somewhat better than 2012's performance when asking rents grew by 1.8% while effective rents grew by 2.0%.
Unfortunately, there is too much vacant space for market dynamics to be conducive to significant rent growth. With the national vacancy rate at 16.9% and declining slowly, landlords remain unable to drive asking rents upward or pull back on lease concessions. That does not mean that rents are unable to slowly creep up - as they did in 2013 - but stronger, healthier rent growth is only possible at far lower vacancy rates such as were observed before the recession. Reis historical data indicates that national vacancies need to compress by another 300 basis points before rent growth accelerates on a broader basis. Given the pace of vacancy declines, it will take another few years to get there.
In the current market environment, weakness at the national level does belie strength found in a handful of metropolitan markets and selected submarkets. With the technology and energy industries of the economy continuing to grow and create a meaningful amount of office-using jobs, the performance of markets with a concentration of companies in these industries continues to excel. This is a familiar trend over the last few years with markets such as Boston, San Jose, Seattle, New York, and Houston generating the highest effective rent growth.
New York has reclaimed the title of tightest market (as measured by lowest vacancy rate) from Washington, DC with a 9.9% vacancy rate at the end of the fourth quarter of 2013. Washington fell to second place at 10.3%. While both markets experienced vacancy rate increases during the quarter, Washington's rise is more troubling. While New York's was likely a short-term aberration, Washington-based employers continue to bear the brunt of budget cuts and political brinkmanship. Although the budget has been passed and the shut- down proved to be ephemeral, haggling over the state of the federal government's finances is far from over.