Office Preliminary Trends, Q4 2018

Preliminary Trends Announcement: National Office Market

 

Office Sector Trends

The office vacancy rate was flat in the quarter at 16.7%. At year-end 2017 it was 16.4%, while at year-end 2016 it was 16.3%.

Both the national average asking rent and effective rent, which nets out landlord concessions, increased 0.7% in the fourth quarter. At $33.43 per square foot (asking) and $27.13 per square foot (effective), the average rents have increased 2.6% and 2.7%, respectively, from the fourth quarter of 2017, barely above the rate of inflation: 2.5%.

Following three quarters of decelerating occupancy growth, net absorption rose to 7.3 million square feet. The fourth quarter tends to see the highest activity in both office completions and leasing. For construction, office inventory expanded by 10.4 million square feet in the fourth quarter, above the previous quarter’s 8.9 million square feet but below the three prior quarters’ average of 11.9 million square feet.

 

National Vacancy & Rent Trends

Source: Reis, Real Estate Solutions by Moody’s Analytics

 

Statistics by Metro

Of the 38 metros that saw a vacancy rate increase in the quarter, most were due to negative net absorption. Metros with the highest vacancy rate increase in the quarter include Louisville, Colorado Springs, Pittsburgh, New Haven and Columbus. Oddly, all of the metros that saw the sharpest decline in vacancy in the quarter were small to mid-size office markets: Wichita, Fort Worth, Norfolk, San Antonio and Greensboro/Winston Salem.

The gap between metros with stronger office metrics and those with weaker ones narrowed in 2018 after widening a bit in 2017. In 2018, only one metro saw a year-over-year rent decline (Fairfield County) and only one saw rent growth above 4% (San Jose); while in 2017, three metros incurred a rent decline for the year, and four saw rent growth above 4%. In terms of office employment growth, 50 of 79 metros saw stronger growth in 2018 than in 2017, and fewer metros saw significant declines as they had in 2017.

Besides San Jose, metros with high effective rent growth for the year include Orange County, Kansas City, Denver, Raleigh-Durham, and Charlotte. Metros with the strongest office job growth include Colorado Springs, Houston, Seattle, Austin, Tacoma, and San Jose. For the quarter, four metros posted an effective rent decline: Little Rock, Lexington, Rochester, and Fairfield County. Metros with the highest quarterly effective rent growth rate were Los Angeles, Raleigh-Durham, Austin, Kansas City, and San Jose.

At 8.3%, New York City still has the lowest vacancy rate along with the highest effective rent of $60.79 per square foot. New York saw the opening of 55 Hudson Yards (1.265 million SF) in the fourth quarter, which was 90% preleased. New York’s effective rent grew 0.5% in the quarter and 2.8% over the year. San Francisco saw the opening of 250 Howard Street (760,000 SF) preleased by Facebook. San Francisco’s effective rent growth for the year was 3.2%.

Office employment growth improves. The U.S. added an average of 51,400 office jobs per month through November of this year, up from an average increase of 49,000 jobs in the same period of 2017. Growth in the metro areas tracked by Reis was 1.9% year-over-year, up from a growth rate of 1.6% in 2017.

 

Office Year-over-Year Effective Rent Growth

Source: Reis, Real Estate Solutions by Moody’s Analytics

 

Conclusion

The national office vacancy rate was once considered the most compelling measure of the overall state of the market. But when it has fallen only 90 basis points from a high of 17.6% in eight years of recovery, one must seek other metrics. Rent growth has been steady throughout the last eight years, but the rate of growth has barely edged out the rate of inflation.

Still, the quarterly rate of effective rent growth was higher in the fourth quarter than it was in any quarter in 2017 and most of 2016 as 2018 saw the strongest overall rent growth since 2015 – not bad for the eighth year of the recovery. More importantly, office inventory has been considerably lower than in recent cycles, averaging 44 million over the last two years, down from an average of 122 million square feet in 1999 through 2001. Completions will be higher in 2019 – close to 50 million square feet including 6.7 million square feet in Hudson Yards alone – while office employment is expected to decelerate. This should push vacancy rates up a bit, but rent growth should remain positive and in line with recent growth rates.

 

Note: Preliminary trends are subject to revision.
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