US office market may have reached bottom

The balance of power is starting to shift back to landlords as US vacancy rates start to slowly decline, according to NAREIM members, with rents expected to stablise in 2011. However, challenges still remain.

The US office market may have reached bottom as vacancy rates and demand for space continue to show signs of improvement, members of the National Association of Real Estate Investment Managers (NAREIM) have said.

Despite 9 percent unemployment and national office vacancy levels of around 16 percent, NAREIM member and chief executive officer of Principal Real Estate Investment Advisors, Patrick Halter, said the sector was now starting to see signs of increased demand from tenants.

US office

“Anecdotally, I am starting to hear from our asset managers that there is a high level of interest and activity in leasing for the first months of this year,” Halter said in a NAREIM article looking at the future of the US office market. Tenants initially believed they had an “abundance of time, leverage and negotiating power” when it came to office deals, however, as the economy improves, “tenants are starting to feel a little hurried to lock in space at lower levels. This is just a slight shift in behaviour on the margin, but tenants are perhaps starting to perceive this as the bottom of the market.”

In the second quarter of 2010, the national office vacancy rate stood at 16.7 percent, but it was expected to fall to 15 percent by the end of 2012, according to CBRE Econometric Advisors this week. “Positive net absorption, fuelled by core office leasing in prime locations, led the rebound in 2010, and resulted in a far better year than anyone could have expected,” said senior economist Arthur Jones, who added that rents should stablise in 2011.

Fellow NAREIM member Paul Michaels, managing director of Invesco’s direct real estate investing group, added that real estate would follow the path of job grow. “That’s the light at the end of the tunnel we’re all looking to find.”

The NAREIM article, however, warned that the US office sector faced a number of fundamentals challenges to future growth, including changing use owing to technology, changing demographics, sustainability and changes in tenant demand, particularly the need to be more flexible.

Tom Garbutt, head of TIAA-CREF Global Real Estate, said tenants were starting to demand shorter leases than the traditional 10-year contract, as they dealt with new accounting rules and the desire for “more control and more flexibility. In other recoveries, at the bottom of the market, everyone tried to lock in rates for the long term. That is happening, but it is less common now even though these are some of the best rents they are likely to find for some time.”

David Congdon, senior vice president of Hines, said technology was also allowing firms to be more efficient in their use of office space. “Law firms are an excellent example of this trend. As their leases come up, they are cutting their square footage significantly. They need a quarter of the support staff they had years ago – and they don’t need to store all their information on paper – no more libraries and a lot less filing cabinets.”