Continued Recovery

Source: CoStar Group Inc.

Source: CoStar Group Inc.

Reflecting a ramping up of office job growth, net absorption of office space increased by 50 percent in the year through the third quarter of 2013, to an annualized 76 million square feet. Because office demand is only growing at a 1 percent rate while office job growth is plus 2 percent, our view is that the office market continues to have upside, with third quarter 2014 demand forecasted at just over 100 million square feet. Since net office deliveries are running at less than half of demand (net absorption) growth, office vacancy rates have declined by 60 basis points over the past year, to 11.6 percent, and they should fall another 60 basis points over the next year. This vacancy decline is finally starting to fuel rent growth, which has averaged 2.5 percent over the past year and should ramp up to the 3 percent range over the next year.

Other significant office market trends:

• Suburban markets are leading the way with 88 percent of the national net absorption, greatly outstripping these markets’ 73 percent share of office space. Their strength has been broadly based, and nine suburban markets achieved more than 2 million square feet of net absorption during the past year.

• A continued flight to quality is evident, with 67 percent of net absorption focused on high-quality four- and five-star space, versus a 34 percent share of the office stock.

• Construction deliveries rose by 30 percent from year-earlier levels, and continued increases are expected. In-process construction is up 9 percent from one year ago.

• San Francisco’s CBD rent growth is head and shoulders above that in other markets, by a whopping 15 percent over the past year and 60 percent cumulatively since the market trough. But the days of outpaced rental growth are likely ending, as more than 3 million square feet of office construction is underway.

• On the capital markets front, the search for investment yield is evident, as office sales volumes are increasing, mainly in suburban areas of primary markets like Boston and Los Angeles. And secondary markets such as Austin, Seattle and Charlotte continue to see strong sales volumes.

• For the first time in 10 years, CoStar’s repeat sales index is reporting that suburban office value growth has exceeded CBD value growth, at 11 percent versus 6 percent, respectively.

—Walter G. Page is director of research – office for CoStar Group Inc.