2005 was the best performance for the national office leasing market since the bubble-induced results of five years ago.
The vacancy rate ended the year at 14.5%, its lowest level in four years, thanks to robust net absorption of 91 million square feet that far outpaced space completions of just 19 million square feet.
Asking rental rates for class A space ended the year up 2.8% in the nation’s central business districts and 4.6% higher in suburban markets.
The amount of space under construction crept up to 55 million square feet from 40 million square feet at the beginning of the year as developers responded to opportunities in a growing number of submarkets.
The office market is responding to consistent economic growth in the U.S. and in most regions of the globe. The most significant economic driver for the office market, as always, was job creation.
Companies have been encouraged to hire in response to healthy balance sheets and surging profit growth, up 17% from the third quarter of 2004 to the third quarter of 2005, according to the U.S. Bureau of Economic Analysis.
Fueling the economic expansion are long-term interest rates that have stayed surprisingly low even as the Federal Reserve consistently raised the short-term federal funds rate since summer 2004.
Low interest rates mean that debt and equity capital remain plentiful in most sectors of the economy, a condition substantiated by the Fed’s Senior Loan Officer Opinion Survey on Bank Lending Practices.
There are some imbalances in the economy that could slow economic growth as early as the second half of 2006 or even bring the expansion cycle to an early conclusion. These are the growing budget and trade deficits and an unsustainable rate of increase in housing prices.
The pace of recovery varies among regions, markets and submarkets.
Through the first three quarters of 2005, absorption was in the black in virtually every market, led by the Northeast, Mid-Atlantic, Southern California and Florida.
During the 12-month period through September, vacancy plummeted by 570 basis points in San Jose/Silicon Valley, the fastest rate of decline among all markets and more than twice the rate of decline in the U.S.
Even so, this market remains soft, with much of the weakness concentrated in large blocks of space. Other rapidly tightening markets include OC, Minneapolis-St. Paul, Broward County and Phoenix.
Earlier in the recovery cycle, analysts were searching for reasons to explain the sluggish recovery of the office market.
Some of these reasons pointed to a permanent reduction in demand for office space. Some of the reasons cited: the offshoring of a growing number of white collar jobs such as call centers to low-cost overseas labor markets, corporate cost-cutting, productivity gains, shrinking space per employee and technology designed to untether employees from their desks were some of the reasons cited.
Yet the office market is performing in the current economic cycle about the same as in previous cycles, absorbing space in response to the growing labor market.
The overall office market is in a classic recovery cycle, with December marking the fourth full year of economic expansion.
With rents beginning to stir in a wider cross section of markets, tenants realize that the days of dictating terms to landlords are coming to a close, and they are jumping off the fence to take advantage of the deals while they last.
2006 Office Forecast
The office market will benefit from the 2 million net new jobs expected in 2006, about one-quarter of which will be based out of office buildings.
New supply totaling 25 million square feet will fall far short of net absorption totaling 80 million square feet, which will reduce the vacancy rate to 12.8% by the end of 2006, down from 14.5% at the close of last year.
Expect the average asking rental rate to rise 5% for space in central business districts and 6% for suburban properties.
An increasing number of markets will move from the recovery cycle to the expansion cycle, the stage where rental rates are high enough to justify new construction.
The greatest risk: A premature recession causes tenants to repeat the massive downsizing and space givebacks that characterized the 2001 recession and its aftermath, sending vacancy rates soaring and rental rates tumbling.
Canadian Forecast
Vacancy rates are falling in almost all Canadian markets. It’s left many tenants with few options.
The booming oil and gas industries have fueled demand for office space in the West, particularly in Calgary and Edmonton. The result has been upward pressure on rental rates.
Many tenants may be pushed to the suburban markets in search of larger blocks of quality space or lower rates, particularly in the Vancouver area.
In Toronto, vacancy rates downtown are at a three-year low amid escalating demand. Plans for more office towers have been announced for Toronto.
Analysis by Grubb & Ellis Co.
