Buyers paid more than $2.5 billion for office buildings in the third quarter. A staggering 74%, or $1.9 billion, were trophy buildings.
Some of the highest-profile buildings in the city changed hands. The highest per-square-foot price ever paid for a class A office building was topped not once, but twice, in the third quarter. Expect investment activity to remain brisk through year’s end with several buildings on the market.
On the leasing side, continued strong absorption hasn’t made a dent in the Atlanta office vacancy rate due to the arrival of speculative space.
More than 656,000 square feet of space debuted in Atlanta in the third quarter, of which 72% was vacant. Those vacancies nearly matched the positive absorption, resulting in a minor decrease in the Atlanta vacancy rate of 19.7%.
This trend should continue into 2007 with more than 2.5 million square feet under construction.
Market Assessment
Job growth in Atlanta continues strong, with 67,600 jobs created through August and a total of 80,000 expected by year’s end.
Overall office vacancy has flattened out as speculative deliveries matched absorption. In what is likely to be the largest deal of the year, Compucredit Corp. is close to signing a 400,000-square-foot lease to consolidate its Atlanta operations into one spot.
The Atlanta skyline is growing fast with more than 2.5 million square feet under construction. As a sign of confidence, several developers have broken ground without any preleasing.
Most of the construction is in the downtown, midtown and Buckhead submarkets. Buckhead posted the most construction with 1.1 million square feet in three buildings.
Forecast
As we move toward 2007, Atlanta benefits from a healthy economy. Employment is expected to be robust, driving swift and steady leasing of office space. As with many of the nation’s markets, the Atlanta office market is like Goldilocks: not too hot, not too cold.
Absorption likely will be positive through year’s end. But speculative deliveries will keep pace and vacancy will continue to remain relatively flat. In 2007, continued speculative construction could shift the balance and drive vacancies higher.
The investment market is hot, with an astounding number of trades in the third quarter. This velocity is driven by the combination of investors’ need to place money and a growing confidence in the strength of the Atlanta economy.
Market confidence is quantified by a 100-basis-point drop in average capitalization rates in the past 12 months.
Combine the sales volume thus far in 2006 with the number of deals set to close before year’s end, and 2006 is set to be a record year for real estate investment.
Vacancy rates for the Chicago central business district and suburban office markets are at the lowest since the third quarter of 2002. East Coast investors are streaming into the market. Does this mean the Chicago office market is over the hump?
The market finished the third quarter in the black with more than 300,000 square feet of positive absorption. This supports an optimistic outlook. The absorption, however, was lower than the second quarter’s 2 million square feet.
According to the Illinois Coalition for Job Growth, the state’s job growth has been slower compared to national levels.
Nevertheless, four sectors grew at a faster rate than the nation’s: finance, information, professional and business services and trade, transportation and utilities.
Asking rents have gained slightly, led by an increase of 26 cents per square foot to $2.91 per square foot for class A space in the central business district. Rents for suburban class A and B space remained relatively flat.
More than 1 million square feet of build-to-suit and speculative office construction is under way in the suburbs. In the Loop, three sites start construction before winter, totaling about 2.5 million square feet.
Even as interest rates rose, investment in downtown office properties is on a record setting pace in 2006 and easily will surpass last year’s $3.3 billion in office tower sales.
Downtown
The central business district office market enjoyed a quiet third quarter, with no buildings delivered and development projects still in their early stages.
Vacancy rates decreased by 10 basis points to 17.1%, fueling hopes the market might gain momentum before the first new building comes in 2008.
Landlords in the Central and East Loop are challenged to keep and attract tenants by the increased attractiveness of West Loop and its proximity to highways and transportation.
The current Tax Increment Financing district covering part of this area is expiring in 2007. A new tax district proposal focusing on LaSalle Street has been submitted to the Chicago Community Development Commission. It’s yet to take action.
Suburbs
Overall, the suburban office vacancy decreased by 10 basis points to 19.5%. The recovery is led by the north submarket with the highest absorption for the quarter.
Speculative construction projects now are under way in some of the submarkets. Developers in others wait for large tenants to sign on.
Rising construction costs make developers cautious. But with rents turning and demand for new office space picking up, they want to be ready when tenants hit the market.
There only are three blocks of class A office space of more than 100,000 square feet in East-West Corridor available, making speculative construction a near-term viable option.
Opportunities, Challenges
A special focus in Chicago is the aging of suburban office buildings
While the overall suburban office market is recovering, the northwest, O’Hare and west Interstate 88 submarkets are seeing vacancy in class B office buildings. These markets have many older office buildings plagued by inefficient layouts, low ceilings, outdated technology and heating and cooling systems, as well as high maintenance costs.
Tenants looking at class B space automatically look for more space than needed, as older layouts were not specifically configured for their operation. On the other hand, less space might be needed for the same tenants in a new class A space they can customize.
This leads to the inescapable fact that class A and B space rates are moving closer together for tenants. As a result, class B,in some cases even class C tenants,are moving up to class A space.
To attract potential tenants, landlords have to offer extremely low rents. If a tenant decides to lease, the landlord might end up losing money by having the space occupied once tenant improvements and building expenses are figured in. So many owners leave their space vacant waiting for a tenant or buyer to take the building.
Forecast
Even as interest rates have risen, investment in downtown office properties still is on a record-setting pace in 2006 and easily will surpass last year’s $3.3 billion in sales. New owners from both coasts are buying,signs of a rebounding market.
With increased construction costs, many buildings are trading below replacement costs, making it a good time for investors to buy.
Despite high construction costs, new buildings still are a viable option as tenants can afford higher lease rates since they do not need as much space in more efficient buildings. The difference of only 5% less space can have a big impact on lease expenses.
Job growth is necessary for a sustained office market recovery. Growing local sectors could generate the job growth everyone anxiously awaits.
Greater Boston’s office market posted another strong quarter with nearly 1.5 million square feet of positive absorption for the 90 days through Sept. 30.
Office vacancy fell by 60 basis points to 14.2%, a rate unseen since the days of the technology boom.
Downtown Boston tightened further with the vacancy rate dropping 30 basis points to 11.4%. The Back Bay saw its rate fall by 60 basis points to 9.6%.
Cambridge also had another robust quarter with its vacancy dropping 1.6 percentage points to finish the quarter at 15.6%.
The northern and southern suburbs posted impressive demand gains, while suburbs running west were relatively flat.
Leading the way in the suburbs was the South 128 market, which saw 485,000 square feet of positive absorption on the quarter.
Asking rents climbed throughout the third quarter; class A rents climbed from $2.47 per square foot in the second quarter to $2.54 per square foot.
Investors are making for a bullish office market, as seen with escalating sales prices and a rise in construction. Recent acquisitions such as One Beacon St. and 265 Franklin St. are raising the bar for going prices for quality downtown office towers.
Central Business District
The central business district again posted a strong quarter with 223,000 square feet of positive absorption, pushing down vacancy by 40 basis points to 11%. Asking rents broke the $3.30 mark.
Rising rents and tighter space is spilling over into the periphery of the Financial District, bringing increased absorption.
Similar stories are playing out in the North and South Station submarkets as vacancies in the central business district become rare.
Suburbs
The suburbs followed the trend set the central business district, with increased class A absorption at the expense of class B.
Landlords in the Route 128 South submarket have come in winners, with a positive demand of 485,000 square feet on heavy leasing activity.
Overall, the suburbs recorded 1.2 million square feet of net absorption in the third quarter. Vacancy narrowed to 15.9%, down 80 basis points from the second quarter. Asking rents edged up slightly to $1.97 per square foot for class A space.
Although net absorption was negative for class B suburban space, asking rents increased to $1.62 per square foot, up 12 cents from the second quarter.
Forecast
All signs point to expansion of the office market throughout greater Boston.
Increasing demand, escalating asking rents, speculative construction, rising investment activity and positive economic growth are working together to move the market in the same direction.
Trends established in the past two years should remain into 2007. Landlords of class A buildings will be the biggest beneficiary, as tenants’ flight to quality and an overall increase in office demand will work doubly in their favor.
Landlords of quality buildings should begin to see signs of growth in the next several quarters as increasing rents in low-vacancy areas begin to price certain tenants out of the market and into the next-best alternative.
The investment market should remain strong as rents are rising to counter the demand for quality class A office space. An increase in net operating income for landlords should result in higher prices for buildings.
The rising market should prompt deals, as many investors change their perceptions to view office properties as providing a potential quick return rather than as long-term income vehicles.
Opportunities, Challenges
Note these opportunities and challenges for Greater Boston:
An abundance of money has seen transaction prices rise to near historical highs. However, with rents increasing at a steady clip and net operating incomes on the rise, there still are many attractive investments in the office market.
Office construction starting in the next few quarters will result in an increase in class A office space in 36 to 48 months, which will accelerate the move to high-quality space by anxious tenants.
Increasing rents in Waltham will benefit the surrounding communities as businesses look to control their occupancy costs by moving to other markets in the Route 128 corridor, or out toward the Westborough/Marlborough area.
Increased Boston-area job growth in the information, financial services and business services sectors will keep office market activity going strong in the next several quarters.
The high cost of living is a challenge employers will continue to face in hiring and retaining talent. A shrinking population base and falling unemployment is reducing the overall pool of workers in the area and may check the growth in office leasing.
