Nation Office Market
New York
The Manhattan office market vacancy rate witnessed a slight decrease in the third quarter to 11.1%, down 20 basis points from last quarter.
Although vacancy has hovered around the 11% level for most of the year, this drop in vacant space is a positive sign that will prime the market for recovery in 2004.
In contrast, overall average asking rents still continue to feel downward pressure, dropping an additional 2.7% in the past three months and raising the year-to-date decline to 6.5%. With anticipated job growth not expected to materialize until 2004, the office market will continue to exhibit similar traits to finish the year.
Midtown vacancy dropped to 9.8% in the third quarter, a 30 basis point reduction from its August peak of 10.1%.
Midtown South’s vacancy rate showed a slight improvement during the third quarter as it dropped 10 basis points to 12.4%.
Surprisingly, the overall average asking rent has been showing positive signs in the past six months in Midtown South, as it was the only market to post a rise in asking rent in the third quarter, albeit a mere 0.1%.
Downtown continues to exhibit positive signs as the vacancy rate dropped another 30 basis points from the second quarter to 13.2%.
Although available space had tapered off since the spring, September saw 1.1 million square feet added to the market. That boosted the availability rate to 14.4%. Midtown accounted for most of the 30 basis point increase as roughly 700,000 square feet of direct space was placed on the market.
Challenges
In the next six months, landlords face the challenge of retaining their tenants while the market is still soft. Creating competitive concession packages will assist in the tenant retention process and keep existing tenants from pursuing space in other buildings.
Tenants continue to have many options with 50 million square feet of available space in the city. Although available sublet space has dropped 13.5% from the start of the year, a little more than 16 million square feet of sublet space still exists.
With the New York economy still lagging behind the national economy, a recession continues in the city. With the unemployment rate jumping 70 basis points to 8.8% in September, the job market continues to struggle locally and won’t improve until at least the middle of next year when job growth is expected to pick up.
Midtown showed positive signs for the first time this year, and vacancy is likely to continue to present moderate drops in vacancy to finish out the year.
Midtown South has prospered this year with vacancy dropping 1.1 percentage points since January; however, the early prosperity will probably flatten out in the next quarter.
Recovery downtown has proceeded quicker than expected, and though pre-Sept. 11, 2001 terrorist attack levels haven’t been reached, the strides made in the past three quarters have positioned the market for a full recovery in the next year and a half.
Boston
Greater Boston landlords will have to wait at least one more quarter before improving general economic conditions translate into flat absorption and stabilizing lease rates.
A limited number of large-space users, decreasing their net space usage through relocations, contributed heavily to the quarter’s 330,000 square feet of negative absorption, sending vacancy rates up 0.4% to 19.6%.
Average class A asking lease rates softened for the ninth consecutive quarter, easing $1.04 to $31.08. The negative absorption was concentrated in a limited number of specific buildings, as four financial district buildings alone accounted for 540,000 square feet of negative absorption.
Though some forecasts call for an increase in hiring activity beginning as soon as the fourth quarter, a construction pipeline expected to yield 3.4 million square feet in the next two quarters, combined with a large potential “shadow space” overhang, suggested by recent job loss activity, will likely result in vacancy rates of more than 21% by the end of the first quarter next year.
Even with flat or modest positive absorption, the increase in vacancy will continue to pressure asking lease rates in this market with 33 million vacant square feet.
Tenants vacated 431,000 square feet in Boston’s central business district during the third quarter, leaving the submarket 13.7% vacant and causing a $1.24 drop in class A asking lease rates to $43.42.
Large tenants, taking advantage of the opportunity to relocate and consolidate, continue to leave vacant spaces in the market, though this activity is likely to cease as positive absorption lessens the number of large availabilities and rental rates increase over the coming quarters.
Forecast
Despite healthy growth in U.S. gross domestic product, dwindling inventories and increases in capital investment, employment growth remains elusive and the Massachusetts unemployment rate hit a new high in the third quarter.
The productivity gains that have enabled this “jobless or job-loss recovery” may, however, be hitting its practical limits, and some experts believe we may be entering a period of increased hiring activity, starting with the fourth quarter.
An improving economy generally results in increased research & development investment, a rule of thumb that should benefit Boston’s knowledge-based institutions and businesses.
A growing awareness of the risks associated with terrorism likely will result in increased investment in the private and public sectors in biotechnology research, a factor which may help Cambridge fill its 1.5 million square feet of BioSciences space.
The improving economy should also spur investment in technology, as well as financial services, likely to help all submarkets.
The construction pipeline likely will cause increases in the vacancy rate within the next two quarters, during which 80% of the 4.2 million square foot under construction is likely to be completed. About 75% of the new completions will either be in Boston’s central business district or in Cambridge, putting additional pressure on vacancy rates in those areas.
Investment activity may pick up in the fourth quarter, as many investors have yet to reach yearly investment quotas. Interest rates continue to be a compelling investment driver from the buy side, especially for private equity investors; as are cap rates, which remain 7% to 8% for highest-quality space, creating prices too high to resist.
Chicago
Solid gains posted in the third quarter convinced many economists to pronounce the “last rites” on the three-year-old slump plaguing nearly every segment of the national economy.
That bit of good news is tempered by a more sobering breakdown of the numbers. Most of the economic expansion occurred during the summer months, particularly July and August when tax cuts and the rush to refinance mortgages were at their highest peak.
There was little indication of an impending recovery in the Chicago central business district and suburban office markets, however, as Northeast Illinois suffered through another quarter of negative absorption, increased vacancy, short-term leases, sluggish hiring and little movement in the construction industry.
One exception: the West Loop submarket in the central business district remained active with 2.5 million square feet scheduled to be added to the inventory by 2005.
Due to a glut of availability resulting from sublease space thrown on the market prior to 2003, new construction (in the central business district), rising vacancies, negative absorption and other market factors, the central business district and suburban office markets remain soft,the worst since the 1992 recession.
The West Loop continues to expand near major commuter railheads and expressways,a trend that has accelerated in the past few years,leaving older class B and C properties in the Central Loop looking for new occupants.
Some of the more historic buildings are being converted to residential developments and hotels, with foreign investors acquiring other downtown properties for investment and redevelopment.
Forecast
Business district vacancy rates are expected to decrease minimally with class A buildings around 16.5%. Minimal declines in vacancy are expected in the suburban office market and vacancy is forecast to remain more than 20%.
A slight increase in absorption is foreseeable, but rental rates are expected to remain flat with a gradual decline expected in both the central business district and suburban market. Tenants will continue to capitalize on market conditions in upcoming quarters and in to 2004 through lease renegotiation or a move up in class resulting from attractive rent differentials and concessions.
