NEW YORK
There has been a slow but steady increase in asking rents during the first three quarters of the year. Landlords are taking advantage of rising demand for space by raising rents and offering less in concessions as they gauge the strength and depth of the market,and try to anticipate its longevity.
The amount of activity this year has already surpassed 2003’s total of 23.5 million square feet, with slightly less than 25 million square feet of leasing activity. y
The slowly improving local economy has fueled the recovery of the real estate market, with positive job gains in each of the past four quarters.
The New York city economy has continued to strengthen throughout 2004. Three major sectors have contributed to its improvement: gross city product grew for the third consecutive quarter, unemployment dropped to its lowest level in several years, and job growth was positive.
These improvements in the city’s economy have helped corporate decision makers feel more comfortable leasing space.
As a result, the Manhattan office vacancy rate dropped to 10.5% in the third quarter, the lowest it has been in two years. Although the positive economic factors are encouraging, Wall Street continues to have profit woes and the city’s inflation rate grew to 4.1% in the quarter,the highest in more than 13 years.
Rising inflation will cause the Federal Reserve to increase interest rates in order to counter the inflation spurt.
Although these changes will have no immediate impact on the office leasing market, rising interest rates may exert upward pressure on cap rates, at least for investment properties.
Downtown
The vacancy rate dropped to 12.9% in the third quarter, down from 13.8% last quarter. Three major tenants moved into their new space, which caused this positive movement in vacancy.
HIP Health Plan of New York moved into its 550,135-square-foot space at 55 Water St., Cadwalader, Wickersham & Taft LLP occupied its 456,101-square-foot space at 1 World Financial Center and Morgan and Finnegan took up its 104,226-square-foot space at 3 World Financial Center.
Although these move-ins bode well downtown, JP Morgan Chase put 886,026 square feet on the market in the third quarter and has plans to vacate its spaces at 1 Chase Manhattan Plaza and 95 Wall St. in the first quarter next year.
These moves will have a major impact on downtown vacancy in the coming year if the spaces remain on the market.
Leasing activity remained tepid at about 500,000 square feet in the third quarter. The Board of Education leased 70,000 square feet at 32 Old Slip, Computer Generator Solutions leased 50,000 square feet at 3 World Financial and Dow Jones & Co. renewed 41,000 square feet at 1 World Financial Center.
The leasing market remains weak downtown, with only 3.5 million square feet of deals this year.
Even with the federal state and local incentive programs in place, it has not been enough to lure tenants downtown. The $3,500 incentive per employee program expires at the end of the year making fourth quarter the last chance for tenants to cut costs on their real estate expenses.
Asking rents continued to trend higher despite any major leasing activity during the quarter. Overall direct asking rents increased 1% in the third quarter to $35.45 per square foot per month. Surprisingly, this increase took place despite the fact that direct class A space dropped 1.5% to $38.32.
Downtown landlords continue to offer attractive concession packages, in quality spaces, doing deals at an average net effective rate in the mid to high $20s.
Forecast
For more than two years, the Manhattan office market has been thought of as a tenant’s market, with its excess of space availabilities and diminishing asking rents. The tides appear to have turned in the past few months as sublease space has begun to dry up.
Landlords, sensing a change in the market, have pulled back on concessions. This is positive news for overall market strength, which means asking rents should continue to rise.
Asking rents remain relatively stable compared to last year at this time. Rents grew moderately in Midtown and Midtown South, while downtown rents are still down from this time last year. Because concessions are starting to subside, deals are getting more expensive for tenants.
Effective rents in Midtown tell a slightly different story for tenants than asking rents since they have increased 7% in the past twelve months.
We have seen an increase in early renewals over the past 18 months. As effective rents continue to increase, we should see tenants take a more serious, focused approach toward their real estate by renewing early.
Conversely, landlords may be less ready to negotiate a new deal as they adopt a wait-and-see attitude regarding how rapidly the market may strengthen.
CHICAGO
Optimism, predicated on higher-than-expected corporate earnings in the second quarter and modestly decreasing suburban office vacancy rates earlier this year, is tempered by a less than rosy economic outlook for Chicago moving into 2005.
Fears of rising interest rates, volatile energy prices and traditional election-year bantering have put investors on edge and tempered economic expansion. Of greater concern to Northeast Illinois is the slow pace of hiring; the area lags far behind improving U.S. rates.
Financial troubles, restructuring, and layoffs beset Sears, Motorola, BankOne, and United Airlines,traditional regional anchors of the corporate sector. None of the recent news emanating from Chicago-based companies bodes well for the beleaguered city and suburban office markets where vacancy rates are 17% and 23%, respectively.
Chicago and its surrounding suburbs are a tenant’s market, and they will remain a tenant’s market in the foreseeable future, with asking rental rates expected to continue to decline.
In the central business district, there are 21 contiguous blocks of 100,000-square-foot vacancies with another 23 blocks of 100,000-plus square feet coming on-line in the next two years.
Landlords, faced with the potential loss of tenants, will continue to grant aggressive concessions including longer-term deals that afford tenants significant flexibility.
The lethargic nature of the Chicago-area economy underscores the length of time it will take the market to return to equilibrium, defined as a vacancy rate of 10%. Things will change slowly in this market.
With a significant imbalance in supply, Chicago and suburban office markets will likely endure another 12-18 months of sluggishness before the long anticipated office market recovery begins.
Forecast
Barring any unforeseen events, the Chicago metro office market will perform predictably during the next six to 12 months. Vacancy will climb in downtown Chicago due to new completions of preleased space. For tenants, it is hard to imagine a better time or scenario for lease negotiations.
In downtown Chicago’s class A buildings, effective rents for lower and mid-level floors are likely to decline further, while high-rise space has reached the low point for this cycle.
In the suburban markets, market activity will be good and absorption levels modest in 2004. It is going to take at least a few years of strong economic growth, job creation and corporate migration to burn off the supply imbalance in the suburban markets. Rent growth is not expected until 2006.
Investment sale activity within the greater Boston office market continued at a vigorous rate during the third quarter, while suburban leasing transaction activity also gained momentum.
BOSTON
New leasing demand was 437,876 square feet of positive absorption, the fourth straight quarterly increase.
Consequently, vacancy declined marginally by 20 basis points to 18.9% overall. While demand for space is slowly recovering, rents have begun to stabilize.
Early indicators suggest that a handful of suburban markets are heading towards a healthier balance between available space and tenant demand.
This news, however, must be tempered with the fact that a number of companies are due to release significant amounts of space back to the market in the coming few months.
Massachusetts continues to struggle with slower, albeit positive, job expansion. For instance, state employment has increased by 25,100 jobs since it hit a low point in February. The number of people employed in Massachusetts (3.2 million) is essentially the same as total employment in August 2003.
Forecast
The office market in greater Boston continues to make subtle and cautious moves towards a sustained recovery. There are, however, a number of concerns given the recent news regarding the amount of potential space coming back to the market within the central business district.
The suburbs are positioning themselves for a stronger rental market in the new year, while central business district rents may stay flat for the first half of 2005 and possibly longer.
A number of construction projects are due for completion during the fourth quarter, including Phase One of the Charles River Plaza and 601 Congress Street.
The supply of new construction is slowing, which will assist in the overall recovery of the market.
Expect the fourth quarter of 2004 to have increased lease transaction volume with stabilized rents in most areas.
Class A space, especially tower space, will continue to lease quickly, as the trend towards capitalizing on relatively inexpensive, quality product continues among tenants.
SEATTLE
The Seattle area economy seems to be in a holding pattern. Washington’s unemployment rate was 6.2% in August, up slightly from 6% in July.
The Seattle office market has been bouncing along the bottom, making small quarterly gains or losses for the past seven quarters. Demand remained in the black with 148,120 square feet of positive net absorption in the third quarter.
The vacancy rate for the Puget Sound office market was unchanged at 16.3%, slightly below the national average of 17.6%. Leasing activity slowed before the elections.
All of this has slowed job growth and kept demand for office space modest. Although vacancy has declined during the past few quarters, tenants remain in the driver’s seat.
Tenants continue to have multiple space options and can negotiate very favorable lease terms in most buildings. Concessions like free rent, parking, moving allowances and tenant improvement allowances are common.
The Eastside office market is beginning to tighten with concessions there on the decline. In the overall Puget Sound market, class A asking rents continue to lose ground and were $25.39 per square foot per year in the third quarter, down from $25.85 in the second quarter. Class B asking rents were stable at $18.77 per square foot per year.
Forecast
Expect a slow recovery for the Puget Sound office market. There are some major build-to-suit projects under way and vacancy may increase as tenants vacate space to fill new inventory.
Washington Mutual is building an 890,000-square-foot office tower in downtown Seattle. King County is deciding whether to build an $89 million, 284,000-square-foot office building at Fifth and Jefferson in downtown Seattle. The county hopes to save millions by consolidating many of their downtown agencies and reducing the amount of space it leases.
In order to reach an overall vacancy of 10%, 5.3 million square feet would need to be absorbed. Assuming 1 million square feet could be absorbed each year, it would take more than five years for the market to reach equilibrium.
Challenges
In most submarkets, this is the best tenants’ market in years. Tenants in some submarkets have an opportunity to renew early while tenants in other markets can secure even better deals down the road. Landlords need to remain aggressive and flexible to capture any demand that comes their way.
Demand continues to outstrip supply in the investment market.
Balance will come as interest rates rise. Until then, suitable investment opportunities will remain in short supply. n
