Orange County
Driven by the combination of a general national economic slowdown and the closing or downsizing of a number of key Orange County high-tech facilities, for the first time in six quarters office absorption in Orange County overall came in at a net negative amount. As a result, traditional office space vacancy overall rose from 7.8% at the end of the fourth quarter to 8.3% the first.
While the county’s inventory of sublease space rose modestly (by just 110,000 square feet), vacant direct space increased by more than 300,000 square feet during the first quarter, resulting in an availability rate (vacant and sublease combined) of 10.5%.
In the flex segment of the market, which Grubb & Ellis tracks separately, vacancy rates have increased somewhat more as a result of building completions and relatively weak absorption.
In comparison to most major U.S. markets (especially areas of Northern California), the Orange County office market continues to be relatively strong. Nonetheless, as the first quarter ended, there were signs that users were being cautious, taking a wait-and-see attitude rather than committing now to new space, at least until the economic picture becomes more clear. At the same time, building owners were more willing to listen to offers, but asking rates in traditional office space were not being lowered significantly.
Los Angeles
The implosion of the tech sector manifested itself in the Los Angeles County office market in the first quarter.
Nearly every office market in LA County experienced negative absorption. The only two areas reporting significant positive absorption in the first quarter were downtown LA and the San Gabriel Valley. They were not enough to keep the LA County office market out of negative territory. These markets suffered none of the dot-com fallout that has plagued other LA office markets, due to their diverse tenant bases.
For downtown, the leasing success has been due in part to the comparatively low average asking lease rates. Average asking lease rates downtown have remained relatively steady over the past year, whereas some of the other office markets in the LA area have experienced significant increases over the same period.
The once glowing success of the West Los Angeles office market that kept the e-companies overflowing into the neighboring South Bay submarkets through 2000 has fizzled out as quickly as it came. The South Bay office market experienced the negative ripple effect of the dot-com phenomenon, but was not overly affected, because of its diverse tenant base. West LA is in its second consecutive quarter of substantial negative net absorption. At the same time, office space users throughout the county are optimistic about the lowering effect this might have on lease rates.
Other Markets
Riverside-San Bernardino:
Moving into first quarter, this suburban office market has held up well against the backdrop of a slowing national economy. Unlike some of the larger, more established office markets that are seeing vacancy rise and absorption drop, the Inland Empire office is posting healthy numbers into the first quarter of 2001. Despite a somewhat graying national economic horizon, the Riverside and San Bernardino County area is still posting strong job and population numbers, which in turn bode well for the office sectors. Even if the local economic numbers are a bit off from the bullish rates of the last few years, they are still outpacing most markets in the state and are still considered by many to be in the “path of growth” moving into the new decade. The total net absorption numbers were buoyed somewhat by the completion of six new projects this quarter. As a result of those completed projects moving into the base of building tracked, there is a bit of a lagging indicator moving into first quarter.
San Diego:
When compared with the record year in 2000, it is evident that a dramatic slowing is taking place in the San Diego office market. While San Diego absorbed more than 200,000 square feet in the first quarter of 2001, it was an 82% decrease in net absorption from the first quarter of 2000. The 200,000 square feet of net absorption is the lowest amount since the third quarter of 1997. Sublease space also increased to more than 700,000 square feet, a 60% increase over the last year. While this space has become available, it has not yet had a major impact on the vacancy rate or asking lease rates.
San Francisco
The San Francisco office leasing market has reversed course after an extraordinary year in 2000. Rising vacancy, falling rents, negative demand and limited leasing activity characterized the first quarter. Downtown San Francisco’s overall office vacancy rate rose from 3.88% in the fourth quarter to 7.66% in the first quarter.
Annual Class A and B lease rents declined from $77.50 and $66.22 in the fourth quarter to $66.08 and $50.03 in the first, respectively. Net absorption recorded its second consecutive quarter of negative demand and its largest in history during the first quarter, at negative 1.25 million square feet. Gross leasing activity totaled 850,000 square feet during the first quarter, compared with 2.2 million square feet during the fourth quarter. Although the number of leasing transactions was slightly greater than in the prior quarter, the average transaction size fell sharply to just more than 8,300 square feet. These daunting statistics have a positive side: at this rate, the San Francisco office market will reach its bottom in the near term and find a new,and more sustainable,level that should bring longer term stability.
Meanwhile, the downtown has diverged from the South Market/Multimedia Gulch district. An unprecedented wave of dot-com leasing activity that began in mid-1999 fueled a brief but meteoric rise in rents and decline in vacancy to previously unseen levels. When the dust settled and the leasing frenzy came to an end in mid-2000, average asking rents had risen approximately 70% in the downtown and 90% in SOMA. Vacancy was less than 2% downtown and near zero in South Market (SOMA) at the end of the second quarter of 2000.
Although the downtown and South Market rode the upcycle just about in tandem, the bursting of the dot-com bubble is having dramatically different downside effects on these two submarkets.
Downtown is holding steady with first-quarter vacancy at 6.50%. Of that, 5.66% is for Class A and 9.86% is for Class B buildings. This is in sharp contrast to SOMA, where the vacancy rate rose to 20.45% in the first quarter,29.55% for Class A and 17.27% for Class B buildings. From their high points last year, Class A and B average asking rents are down 18.0% and 27.2%, respectively, in downtown and 24.3% and 36.3% in SOMA, respectively.
The explanation for this differing performance is not too surprising. Downtown is a 43.5 million-square-foot market and SOMA (including all property classes) is an 8.0 million-square-foot market. Based on our analysis of leasing activity since 1997, dot-coms have leased approximately 9.6 million square feet of office space,4.1 million in downtown, 3.9 million in SOMA, and 1.6 million in other non-downtown areas. Thus, dot-coms accounted for only 9.2% of the downtown market, but nearly 50% of SOMA. Approximately 3.3 million square feet of mostly vacant dot-com space has been returned to the market,1.4 million downtown and 1.2 million in SOMA. Clearly, the amount of space returned to the much smaller SOMA submarket is having a more pronounced effect. Thus, it is likely that SOMA will continue to bear the brunt of the San Francisco office market downturn.
In contrast, the rate of decline downtown has slowed over the past three months.
After rising by nearly 2.5 percentage points in January and 1.0 percentage point in February, vacancy was little changed in March. Although there has not been a sufficient amount of leasing activity to determine at what level rents will begin to stabilize, it should not be too far behind the vacancy rate trend.
From a historical perspective, the prior office market downturn of the late 1980s to early 1990s saw a downturn in vacancy in the 10% to 17% range and Class A rent declines of 35%. Despite different circumstances, history has a tendency to repeat itself and the current cycle may not be too different, except the vacancy falloff should be at the low end of the range.
Other Markets
Colorado Springs:
Softness in the tech industry caused large amounts of sublease space to come on the market in Class A office buildings. Vacancy rates will increase and rental rates will start to show some decline. This will be noticed more in second-quarter statistics.
Dallas-Fort Worth:
The DFW office market saw mixed blessings. The recent downturn in the economy sent the quantity of sublease office space soaring. The downfall of the dot-coms, the ensuing struggle in the tech sector and layoffs within the general economy collectively contributed to a 60% rise in DFW office sublease space during the first quarter. As a result of the excess sublease space, direct lease rates remained flat.
Whether that situation is desirable depends of course on one’s perspective. Property owners and leasing managers are finding themselves competing with a large quantity of attractive sublease space at reduced rates, giving tenants more leverage in lease negotiations. However, property owners and managers are becoming increasingly wary in terms of who they lease office space to, while stiffening the lease terms of those they complete. Letters of credit are becoming more common requirements in addition to a greater portion of the rent being paid up front prior to occupying the space. Yet this cycle is like all others in the real estate industry: it too will rise and fall. Expect the sublease space “glut” to soon subside as bargain hunters snatch up the good deals. An abundance of quality office sublease space is available in Dallas/Fort Worth, but how much is too much to be a good thing?
Denver:
For the first time in recent history, the Denver metro area experienced negative net absorption,450,946 square feet of it,sparked mainly by company downsizing from such firms as Lockheed Martin, Level 3, Verizon Wireless and Samsonite. As a result, vacancy rates in the metro area increased almost 2% since year-end 2000, which has helped to stabilize rental rates and forced landlords to offer more concessions in order to lure tenants to their buildings.
Despite factors pointing toward an economic downturn, new construction and planned projects continue to be on the rise. More than 1 million square feet of new product was delivered to the market during the first quarter and more than 3 million square feet were under construction at the close of the quarter. Combined with the 5 million square feet of planned construction, Denver may be creating an oversupply of space where the demand is not there. But so far the plug has been pulled on only a few projects, such as the 800,000-square-foot campus that was proposed for the Lowry Redevelopment by Janus Capital Corp.
Eugene:
The metro Eugene office market sent mixed signals in the first quarter. The office vacancy rate, at 5.5%, was healthy in all areas except for a few unique instances and Class A space saw a lot of activity, while the lower tiers softened. In terms of development, the first quarter came and went with the same issues that plagued 2000. Developers met many challenges in dealing with the city of Eugene on downtown office projects as the land use code limited development.
Houston:
Strong space demands and low vacancy rates are fueling new construction and building renovation in Houston’s central business district. Downtown remains the tightest office market with Class A occupancy rates consistently above 95% for the past three years; robust space demands in high-quality buildings prevail. As a result of this “renaissance,” developers have renovated and begun construction on several office towers. During the first quarter, the appropriately named Renaissance Tower, at 1801 Main, reopened its doors after a long-awaited redevelopment. Southwest Bank of Texas was one of the first tenants to occupy the 219,051-square-foot property. Meanwhile, Travis Tower, at 1301 Travis, is another property that recently underwent extensive renovations. Enform Technologies, a major tenant, brought up its occupancy to more than 75% of the building. More important, for the first time in 15 years, Houston will be adding towers to its skyline.
More than 2.6 million square feet of Class A office space was under construction in the downtown, of which 78% was preleased. Enron Tower, an owner-occupied building, is scheduled for completion in the second quarter. 5 Houston Center, the smaller of two speculative properties with 576,964 square feet, will be delivered during the third quarter, while 1000 Main,likely to be dubbed Reliant Resources Plaza,will add nearly 800,000 square feet of speculative space to the downtown inventory within the first few months of 2003.
Las Vegas:
Office growth has slowed considerably over the past year due primarily to tougher lending criteria. Lenders have increased restrictions for spec buildings due to the economy slowing down. Vacancy and absorption is also down.
Oklahoma City:
With increases in occupancies, absorption and rental rates during the first quarter, the market is geared for a positive 2001. The downtown, which historically has maintained the highest vacancy rate, saw the greatest square footage absorption in the city. Recently available Class A space gained much attention as the vacancy rate in this class dropped more than 4%.
Phoenix:
There is no question that the metro Phoenix office market was slower in the first quarter, at least in part because of the national economy. As a result, businesses and investors were cautious to commit to office space, lowering the levels of sale and leasing activity. While it may seem discouraging, the upside is that Phoenix fared better than many other cities across the United States.
Portland:
The Portland office market began to feel the effects of a slowing national and regional economy in the first quarter. There were signs of slowing late in 2000 and those warning signs were borne out. However, the diversified economy and the Urban Growth Boundary, which has limited new development, both served to insulate the office market from the drastic swings in the national economy.
Some tech-heavy submarkets in Portland have been hit harder than the rest of the region, but their relative size means that a rebound should be coming in the next two to three quarters. Still, the market has seen the return of some modest concessions, primarily in the form of free rent, and many developers have changed their construction plans to hold out for significant preleasing activity or a build-to-suit tenant. It has been a long time coming, but after several years of the landlord as king, tenants in the Portland market have gotten a respite. The past two years have been unreal for landlords, with 100% occupancy and tenants lined up to pay more than asking rates. Reality has come crashing in and landlords will have to be content with a standard occupancy of 95% and some competition for tenants.
With vacancy rates inching up and an uncertain economy, landlords are starting to utter words that tenants have not heard in some time,”concessions.” For the past several years, tenants were faced with very few options and often had to compete for space with other tenants. Tenants are now finding that they have several options to consider when looking for space and landlords are being more flexible with terms.
Reno:
The slowdown in the national economy had some minor effect on the Northern Nevada office market in the first quarter. Tenants were a little slower to negotiate leases. Sublease space increased over the quarter, but several new development projects have been put on hold, which should help stabilize the market.
Sacramento:
Sacramento has yet to be affected by the national economic slowdown. Ten of 11 sub-markets posted lower vacancy rates than in the fourth quarter. Overall market vacancy is 8.69%. Rental rates are inching up. Absorption was a positive 230,000 square feet. And there was more than 3 million square feet of new office inventory under construction at the close of the quarter.
Salt Lake City:
Activity in Salt Lake’s office market began to slow. Asking lease rates on some older properties dropped and recently vacated space was slower to fill. Even so, Class A space downtown remained in short supply. This could change, however, as downtown tenants vacate occupied space to move into the newly available American Stores Tower.
San Jose:
Like many markets, demand softened considerably in the first quarter and rents stabilized. The tenants who were in the market opted to wait things out to negotiate the best deal possible. Tenants also had a much greater choice of product than they did six months ago. The sales market had not yet experienced the same slump. The sublease vacancy rate doesn’t necessarily tell the whole story, as a great deal of the new space was would-be sublease space recaptured by the landlord. Several big planned developments were indefinitely delayed.
Seattle:
The tech downturn pushed the vacancy rate up to a still-healthy 4.3%, but bargaining power shifted dramatically from landlords to tenants during the first quarter. Net absorption underwent an incredible decline from the fourth to the first quarters, dropping from a positive 1.5 million square feet to a negative 80,000 square feet. Asking rates were stagnant, and even declined in certain submarkets for the first time in recent memory. Boeing’s surprise announcement that it will move its corporate headquarters to Chicago may put up to 435,000 square feet for lease in the marketplace, but the psychological effect of the move will be far greater.
