Forward March

Source: CoStar Group Inc.

Demand for office space is now recovering at a measured pace, with net absorption rising from 31 million square feet in the first quarter of 2011 to an expected 88 million square feet by the first quarter of 2014. Because new office deliveries are running at less than half of demand (or net absorption), office vacancy rates have declined by 110 basis points in the past two years, to 11.8 percent as of the first quarter of this year, and should fall to 11.2 percent by the first quarter of next year. While growth in office rents has generally been disappointing at 1.3 percent nationally over the past year, we are expecting modest growth of 2 to 4 percent per year through 2017 as vacancy rates fall below the long-term average of 11.4 percent.

Technology and energy markets are leading the way, with San Francisco head and shoulders above other markets with a whopping 10 percent rent increase over the past year and a 40 percent cumulative increase since the market trough. San Jose has also done well, although the cumulative rent increase has only been half of San Francisco’s. Office markets in Boston, New York, Houston and Seattle each posted 3 to 5 percent rent growth year-over-year, with their close-in, highly desired locations generally achieving the highest rent growth.

Increased use of alternative office strategies such as hoteling and telecommuting is expected to constrain office demand. In particular, use of the Internet and other advances in remote location technology, on top of existing gray space, is expected to contribute to reduced office demand. Already, over the past 10 years, the average new tenant lease size has declined by 20 percent.

And with a relative lack of new construction in the majority of metros, for the most part office rents are below construction justification levels, which should allow for solid gains in occupancy and rent as the recovery matures.

—Walter Page is director of research for the office sector at CoStar Group Inc.