The U.S. Office Market: Normal or Bull Market?

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While the economic recovery is crawling, the U.S. office market overall is improving. Depending on location and class of building, market performance can vary widely.

A recent episode of “America's Commercial Real Estate Show” presented an enlightening look at the office market's performance in the second quarter. Overall, my guests were pleased with the progress the sector has made, especially since the dark days of late 2008 and 2009.

Walter Page, Director of Research, CoStar Group

Walter Page, Director of Research, CoStar Group

Normal

“I would classify [the sector's second-quarter performance] as a return to normal,” said Walter Page, director of research for CoStar Group.

Compared to the end of the first quarter, the national office vacancy rate dipped 20 basis points in the second quarter to 12.6 percent, Page said. The rate represents a 70-basis-point drop from second-quarter 2011.

Net absorption of office space totaled 18 million square feet in the second quarter, up from 9 million square feet in the first three months of the year. Overall, office rent growth has yet to take place in earnest but some tech-heavy cities such as San Francisco, as well as Class-A assets nationwide, are experiencing increases, Page added.

However, more areas are on the verge of joining the fun. “With the lack of new construction and the expectations of declining vacancy rates, you're reaching a tipping point in many markets where we're going to start seeing rent growth,” Page said. “It's happening in markets across the country.”

Transaction volumes are generally healthy and cap rates for core investments in top-tier markets continue to decline, according to Page.

Bull Market

Mitch Roschelle, a partner with PricewaterhouseCoopers, was even more enthusiastic. “I'm incredibly bullish on [the office sector],” he said. “Investors have gotten away from just looking at the core markets and are looking at markets coast to coast.”

As for the sector's future, “we see rent growth, positive absorption and an increase in demand coupled with a historic fall in supply,” Roschelle added.

Mitch's observations prompted me to note what a sound investment commercial real estate can be. “Commercial real estate investments can be relatively safe ones when you look at all the other choices,” I remarked. “Because of the lack of new construction, it kind of takes care of itself in some ways.”

Election Impact

I'm always curious to hear my guests' opinion on what effect the upcoming presidential election could have on the commercial real estate industry, and I thought their remarks were especially interesting in this show.

Roschelle largely discounted the impact that either a second Obama administration or a new Romney one would have on commercial real estate. However, he did say the rhetoric leading up to the election could have an adverse effect.

“If investors hear campaign rhetoric that suggests the interest rate environment may change, that regulations may change, that lending practices may change – that could cause concern on [their] part,” he said.

Historically, however, “one party or another hasn't really had an impact on the sustainability of cash flows and the performance of the asset class,” Roschelle concluded.

David Tennery, a principal of Regent Partners' Office Properties and Development Group, was more pointed in his comments. He noted that office tenants are anxious about the federal debt and are therefore hesitant to spend their cash reserves; a trend he hinted could dampen the office sector's recovery.

“I can't see these folks making the decision to spend on additional jobs and/or corporate facilities until there's a pop in consumer confidence, and I certainly don't see a consumer-confidence pop under the current policies of the [Obama] Administration,” Tennery said.

Jim Bacchetta, VP, Highwoods Properties

Jim Bacchetta, VP, Highwoods Properties

Activity

On a happier note, both Tennery and Jim Bacchetta, a vice president with Highwoods Properties, said their firms have experienced noticeable upticks in activity at the office buildings they own and manage.

“We're up over last year significantly in signed deals and traffic overall, and [last year] was up over the previous year,” Bacchetta said.

We're seeing much more activity at Bull Realty as well and have been since the start of the year. The signs are encouraging. Job growth may not be quite what we want, but there's no doubt the office sector is improving and is in much better shape than several years ago.

The entire episode on the second-quarter U.S. office market is available for download at www.CREshow.com.

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