Now may be the time to have a thick office portfolio. Throughout the nation, rents are increasing, absorption is positive and even long-beleaguered CBDs are attracting attention from office-space users. Of course, you cannot keep a good thing a secret - new product abounds with developers' hopes of riding the office market wave to even higher levels. But for now, nearly everything built is leased, so there is no need to worry much about overbuilding - at least for a while.

National performance measures The performance of the nation's office market during the first part of 1999 was a bit surprising, given the strength of the current economy, according to Robert Bach, Grubb & Ellis' national director of market analysis. "During the first quarter, we saw a slowdown in net absorption coming on the heels of a slow fourth-quarter 1998," he says.

Among the 35 major U.S. office markets tracked by the Northbrook, Ill.-based commercial real estate services firm, some 5.2 million sq. ft. of space was absorbed during first-quarter 1999, vs. 8.4 million sq. ft. the previous quarter, reports Bach. By comparison, absorption averaged about 16.1 million sq. ft. quarterly during the first nine months of 1998.

Overall, U.S. office market vacancy stood at 10.74% at the end of first-quarter 1999, up slightly from the 10.36% registered three months earlier, but well within the 10% range exhibited since the end of 1997.

There could be a number of reasons behind the slow pace of office absorption in early 1999, notes Bach. "One could be the low corporate earnings of last year, which may have put a damper on a lot of companies' expansion plans. "The business press was so negative late last year (during the global capital markets crisis) that a number of corporate expansions were put on hold."

Alternatively, "Companies may have been reacting to the way rents have gone up," says Bach. According to Grubb & Ellis statistics, rents have been rising at a 10% to 15% quarterly pace since the beginning of 1998. "The upward pressure is still there all over the country," he notes, "although new construction may ease things over the course of the coming year."

Absorption has slowed with declines in office employment growth, according to Christopher Ludeman, president of brokerage services for Los Angeles-based CB Richard Ellis. Total U.S. office market absorption dropped to 63 million sq. ft. in 1998, down from 1997's figure of 68 million, he reports. During the same period, the pace of office employment growth slowed from 5.5% to 4.3%.

Despite the absorption slowdown, the office market remains tight, says Ludeman. "We have not dramatically oversupplied the office market," he notes. "We owe this largely to the capital market shock we felt at the end of third-quarter 1998, which sent the construction financing world into a bit of a shutdown for a while."

"Combine this shutdown with the concerns people had about REIT overbuilding, and the result has been a slower, lower level of projects moving through the approval process," says Ludeman. "Capital remains disciplined, which will further moderate the level of completions for the next several years."

"Underwriting criteria has recently been, for the most part, pretty disciplined," agrees Jimmy Gunn, president of property services for Chicago-based PM Realty Group. And at the same time, "There has been a ton of office development, most of it done responsibly," he says. "Virtually every office market we work in is either at an all-time high or on the upswing."

Investment angles On the investment front, "We are seeing investing in new office construction come back in vogue," says Janice Stanton, director of investment research for New York-based Cushman & Wakefield.

Currently, about 68 million sq. ft. of office space is under construction in the nation's suburban markets, and around 12 million sq. ft. in downtown markets, according to Stanton. "Both markets are in equilibrium," she says. "Rents have recovered to the point where, in most markets, they are at replacement cost, if not above." Today's wave of suburban office construction began around three years ago, says Stanton, while new office construction in CBDs cranked up only recently

Buyers are back in the market for office, says Stanton, with pension funds in the lead. "Pension funds were last year's under-bidders," she reports, "but this year, they have really stepped up to the plate in terms of being the lead buyers of office properties.

"There is a tremendous appetite among international investors for office, with growing interest among Middle Eastern investors, and strong activity among German investors for solid-quality institutional product," Stanton continues. At the same time, "REITs have stepped back a little as buyers," she says. "Instead, they are joint venturing with private investors and pension funds to develop."

Overall, "prudent" appears to be the watchword among office property investors these days, says Stanton. "There was a sense last year that buyers were getting into bidding wars, and perhaps overpaying. People are paying good prices," says Stanton, "but there doesn't appear to be any kind of bidding frenzy taking place."

Chicago-based CMD Realty Investors focuses its attention on suburban office product, "Although we'll occasionally look at a downtown deal," according to executive vice president Dick Schaller. The company has its reasons for this strategy.

"We are pretty much convinced that the employee base most employers want to attract is becoming more and more suburbanized," he notes. "And in today's tight employment market, office-based employers want to locate where the employees are - and for the most part, that is in suburban markets." A developer's view

>From a development perspective, the nation's Sunbelt is the major focus of >attention for The Alter Group, Lincolnwood, Ill., according to the >company's executive vice president Richard Gatto. "The Midwest markets are >healthy," he says, "but they don't seem to have the velocity of demand >that you see in the southern part of the country."

Within Sunbelt markets, the suburbs are the venues of choice for office developers, says Gatto. "As Corporate America increasingly uses its real estate as a tool to attract labor," he says, "we're seeing new office development reach out further into outlying residential areas, resulting in easier commutes for employees and giving employers located in these developments a leg up in the recruiting process."

On the financing front, REITs are having a harder time finding capital due to declining share prices and their inability to take on a lot of debt without raising the eyebrows of stock analysts, according to Gatto. Meanwhile, banks are becoming a bit more cautious, he says, as reflected in their underwriting and loan terms.

"We are starting to feel a general sense of tightening," says Gatto. "But, we are not anywhere near a situation where good-quality deals sponsored by strong balance-sheet developers are having problems [getting financing]. At the same time, however, "I can see where some of the more marginal deals are starting to feel the pinch."

The Northeast New York The only pinches Midtown Manhattan owners and landlords feel these days are the ones they give themselves to make sure they are not dreaming. "The high rents in this market are surprising even the veteran players in this marketplace," says Ira Schuman, executive vice president at New York-based Julien J. Studley and co-branch manager of the firm's Midtown Manhattan office.

According to the second-quarter 1999 Studley Report & Space Data report, the 303.6 million sq. ft. Midtown Manhattan office market was 5.7% vacant, with the 81.7 million sq. ft. Class-A market segment only 3.8% vacant. Class-A rental rate quotes in Midtown averaged $55.35 per sq. ft. at the end of the second quarter, compared with an average of $38.85 in the adjacent Downtown market.

"Class-A rents, including various concession packages, start in the $40s," according to Schuman, "and, unfortunately, can go as high as the $80s." The result of a strong economy and virtually no recent construction, these high rents are surprising even landlords. "They can't believe how good things are these days," he notes, adding that, "They still give tenant concession packages so as not to risk messing things up."

This strategy seems to be working. Tenants absorbed a net total of 1.18 million sq. ft. of Class-A Midtown office space during 1998, according to the 1999 Tenant's Guide to North American Markets, published by Dallas-based Corporate Real Estate Services Advisors (CRESA). The report also notes that tenants seeking new Class-A facilities are now facing asking rates $7.95 per sq. ft. higher than a year ago.

Boston With space in high-profile downtown Boston office towers scarce, rents have risen dramatically, according to Cornerstone Properties vice president Larry Melo. "There were a number of high-profile deals with gross rents in excess of $60 per sq. ft. during fourth-quarter 1998," he reports, a function of major users "stockpiling" space in anticipation of a tighter market.

As rents increased, activity slowed. "Tenants are a bit scared that they'll make commitments in the $50 range and then the market will slide," says Melo, "and that they'll wind up being congratulated on leasing space at the top of the market."

Vacancy in downtown Boston towers is less than 1%, reports Melo, with the market as a whole at around 3.6% vacant. New construction is scarce, he notes. "New towers, unless they already have a 'bird in hand,' need to sell a tenant on asking rates that average in excess of $52 per sq. ft."

At 4.8% vacant, the market is only slightly looser in the Cambridge submarket, according to Melo. New construction here is constrained by what is known as "IPOP," which stands for "Interim Planning Overlay Petition," a requirement that any new development larger than 50,000 sq. ft. be subjected to an especially rigorous approval process.

In contrast, the Boston suburban office markets are growing, with some 2 million sq. ft. to 3 million sq. ft. underway, says Melo. But, "We haven't seen a strong migration out of the CBD into the suburbs," he reports. Instead, space-strapped users, such as mutual fund giant Fidelity, still scramble for space in the CBD. "What Fidelity found was that the main component of their workforce is young, single, straight out of college and wants to live in the city," explains Melo. Given the prospect of relocating to the suburbs, he adds, "This group would rather change employers."

The Southwest Dallas New construction deliveries in the Dallas-Ft. Worth metroplex hit the 3 million sq. ft. mark during first-quarter 1999, according to Cushman & Wakefield. Another 10.4 million sq. ft. is under construction and slated for delivery in the next 12 months, according to Tommy Van Zandt, senior vice president, office division, for Houston-based Transwestern Commercial Services.

"But that's not as bad as it sounds," says Van Zandt, adding that 30% of that space is preleased, while the market absorbs 5 million sq. ft. annually.

"There will be a little bit of a hangover in terms of supply and a few submarkets that will soften up a bit," says Van Zandt. "But on the whole, when you look at a 157 million sq. ft. market like Dallas and you end up with a couple-of-million-square-foot hangover of space during a one-year period, that's really not affecting the overall numbers that much."

A strong regional economy has buffered the Metroplex office market from the impact of overdevelopment in the past. "Our job growth is still better than most places," says Elysia Holt Ragusa, president of southwest corporate services for The Staubach Co., Dallas. But that growth is slowing, she notes. "And between the slowing of job growth and the square footage we've got coming on line, I think we're in for a little softening here."

Most of this market's new office development is taking place in the North Dallas Tollway submarket, says Van Zandt. "This is the center of business for the Dallas Metroplex, which means that it is creating the most in the way of office demand and also in the way of supply."

And in the Downtown Dallas submarket, "Double-A space is pretty full, but we've got a lot of double-A space that is just kind of sitting there stagnant," says Ragusa. (For more on the Dallas market, see our city review starting on page 74.)

The West West Los Angeles

Continued growth in entertainment- and Internet-oriented businesses drives activity in the West Los Angeles office market, according to Rick Gold, senior executive vice president for Encino, Calif.-based Capital Commercial Real Estate/NAI. "A lot of the new buildings are being designed specifically to meet the requirements of these users," he reports, incorporating fiber optic cabling and DSL lines and, in the case of the entertainment production companies, higher ceilings.

Demand for premiere space fueled developers to break ground on several spec buildingshere during 1998, according to CRESA. Nearly 1 million sq. ft. in Santa Monica and 800,000 sq. ft. in Glendale are underway, their report notes, with delivery planned for late-1999 and early-2000.

The new space is hitting a tight West Los Angeles market, notes Gold. "Downtown L.A. still has a vacancy rate close to 20%, while the west side is in the low single digits," he says. Tight space means high rents here; according to Gold, rents are now exceeding the $36 per sq. ft. annual level in the market as a whole, "with a couple of buildings in Century City trying to get $45 to $48."

Phoenix Proximity to Southern California, strong job growth, affordable housing and quality of life helps drive demand for Phoenix office space among a variety of user types, according to Lend Lease Real Estate Investments' senior vice president Christopher Casey. Speaking from his office in Irvine, Calif., he notes that "A number of large financial services firms, such as Charles Schwab & Co. and American Express, are huge space users here." Meanwhile, Intel's chip plant in the area has resulted in a number of office-based spin-offs, says Casey.

In partnership with Houston-based Hines, Atlanta-based Lend Lease is building an eight-story, 300,000 sq. ft. building in the Camelback Corridor, a submarket marked by proximity to executive housing and gross rents in the $27 to $30 per sq. ft. range, according to Casey. The suburban Scottsdale submarket commands rates in the same range, he reports, and has relatively high vacancy due to a strong level of new construction. "Overall, Phoenix vacancy is a shade under 10%," adds Casey, "with the downtown portion of the market at close to 15%."

Salt Lake City The locale for the 2002 Winter Olympics has an office market comprised of some 5.9 million sq. ft. downtown and another 8.8 million sq. ft. in the suburbs, according to Ken Cooley, COO of Dallas-based L&B Realty Advisors. "As a whole, the market absorbed what was built during 1998," to the tune of around 2.5 million sq. ft., he reports. "This is a market that is in equilibrium."

Downtown office market vacancy in Salt Lake is around 6%, says Cooley. "Unlike many of its counterparts across the nation, downtown Salt Lake City has a lot of retail," he notes. It is also the center of intense preparations for the upcoming Olympics, including a reworking of its roadways, the construction of rail transportation, an expansion of the existing civic center and the development of several new hotels. And lately, "A lot of downtown users are heading for the suburbs in search of bigger floorplates and more suburban settings," says Cooley. The suburbs are also in the 6% vacant range, he says, with gross rents averaging $19.25 per sq. ft., versus $19.75 per sq. ft. for downtown.

Cooley is positive in his outlook for this market. "What we find on the national level is that companies like the Salt Lake City market because of its very young and very educated workforce, along with its strong pro-business climate," he says. Labor costs are still fairly low here, says Cooley, and with the Olympics, "Salt Lake City is now getting recognition as an international city."

Mid-Atlantic/Southeast Metro Washington, D.C. Times are good in the Washington, D.C., Northern Virginia and suburban Maryland markets. In the 112 million sq. ft. Northern Virginia marketplace, "There has been an unprecedented absorption of office space," according to Peter Larson, managing director at Atlanta-based Advantis Commercial Real Estate Services. A 2.4 million sq. ft. net change in occupancy brought the first-quarter vacancy rate here down to 5.5%.

In Washington, D.C., first-half 1999 absorption of more than 3.1 million sq. ft. brought vacancy in this 96 million sq. ft. market to the 7.5% level. Meanwhile, the 79.7 million sq. ft. suburban Maryland marketplace ended the second quarter at 9.1% vacant, with more than 2.4 million sq. ft. absorbed in the first half of the year, according to Studley's Report & Space Data second-quarter report.

New construction is prevalent in all three markets, according to Advantis research and marketing director Jeffrey Tanck. Northern Virginia is in the lead with some 8.1 million sq. ft. of space underway, he reports, with about 50% of that total currently uncommitted. At the same time, only around 40% of the 2.9 million sq. ft. underway in D.C. is not preleased.

After a period when leaving D.C. for the suburbs was the order of the day, this dynamic has changed, according to Jim Creedon, senior vice president of Arlington, Va.-based Charles E. Smith Commercial Realty/NAI. "We've certainly seen a shutdown in the exodus," he notes. "D.C. is enjoying a lot of growth now, much of it from law firms and associations." Among the latter group, the American Gas Association recently relocated from Northern Virginia to D.C., "Because their membership wanted the higher visibility that comes with a D.C. address," Creedon reports.

The price of entry into Class-A space in Northern Virginia markets such as Tysons Corner has reached the $35 level, according to Larson. At the same time, "Downtown D.C. has experienced a rebirth of some exciting numbers, which are now north of $40 [per sq. ft.] in some buildings," says Creedon.

Miami Rents are increasing while vacancy is declining in the 70 million sq. ft. Miami office market, reports L&B Realty Advisors' director of asset management Ed Daley. "The overall downtown vacancy rate is now just under 17%, with Class-A space about 12%," he says, "while the suburbs are probably even less vacant." Meanwhile, the Brickell submarket is 11% vacant overall; under 7% in the Class-A sector, says Daley.

Class-A rental rates run from $24 to $34.50 in both downtown Miami and Brickell, says Daley. In the downtown market, "Landlords are tending to hold the line as far as rental rates and concessions," he says. At the same time, the 500,000 sq. ft., 20% to 40% preleased Barclay's Financial tower "is going to put a ding in the Brickell market for a while."

Overall, "Miami is one of those steady office markets, large and diverse, where if one sector slows, there's another one there to pick up the slack," says Daley. Legal, accounting and financial firms - mostly regional offices - dominate the user profile in downtown, he notes, while import/export, tourism and foreign-related businesses are in evidence throughout the market.

Atlanta This is a good time to be a tenant in the Atlanta market, according to T. Bradley Fulkerson, vice president/office brokerage for locally based Carter & Associates*ONCOR International. "Vacancy rates trended down a bit during the second quarter," he says, "but are still high, as they have been for the past several years, particularly for Class-B space."

Although construction has slowed somewhat, there are many new projects still in the pipeline, says Fulkerson. "There is also a fair amount of what we classify as 'stealth development' - large blocks of older space that are becoming available because tenants are moving into new space."

According to Carter statistics, the 106.7 million sq. ft. metro Atlanta (Class-A and Class-B) office market was 11.6% vacant at the end of the second quarter. Year-to-date absorption totaled 865,234 sq. ft., with weighted average rental rates in the $20.15 to $20.80 range. And, according to CRESA, there is more than 5.4 million sq. ft. of space underway.

Atlanta's newfound status as the nation's poster child for suburban sprawl has led many of the area's downtown boosters to proclaim the resurgence of the CBD office market. "And it is not just hype this time," says Sam Holmes, executive managing director of Insignia/ ESG in Atlanta.

Positive office-related developments taking place in downtown Atlanta include the 650,000 sq. ft. expansion of SunTrust Plaza, the growing space needs of major employer Georgia-Pacific and BellSouth's reconfiguration of its office facilities to clusters around inner-city transit stations, according to Holmes.

"Unfortunately, all of these positive events involve existing users already located in downtown Atlanta," he notes, adding that, "We have seen limited to no interest from corporate relocation prospects."

The Midwest Chicago Several massive office developments are on the drawing board for Downtown Chicago, but only smaller properties are coming out of the ground, according to Rand Diamond, president of GVA Williams of Illinois. Developing office space in downtown Chicago is an expensive proposition in the first place, says Diamond, and rents need to net out in the low-$20s for projects to work. But, more importantly, he adds, "There are not that many 300,000 to 400,000 [sq. ft.] tenants around to anchor one of these buildings."

Rents for existing space currently run in the $22 per sq. ft. to $24 per sq. ft. range for Class-A space downtown, according to Diamond. "It is important to remember that downtown taxes (passed on to the tenant) are considerably higher than those in the suburbs," he notes. What Diamond calls "absolute Class-A space" is a scarce commodity here, "While there are quite a few options available in the A-minus to B sectors of the market."

In the Chicago suburbs, the price of entry for Class-A space is in the mid-$20s on a gross basis, according to Jonathan Malm, vice president of Rosemont, Ill.-based McShane Corp., with some "super-Class-A buildings" in the high-$20s. The East-West corridor and the North Suburban submarket are the most active in terms of new development and deals, he reports. Malm adds that the hot product in the East-West Corridor is the single-story office building, a product McShane develops, with price points that undercut those of mid- and high-rises by $2 to $3 per sq. ft.

"There is currently significant demand for office call centers - single-story product for which the end user can achieve generous tenant improvement allowances, economics and parking ratios," says John Noonan, vice president of Rosemont-based Colliers, Bennett & Kahnweiler. "There has been 326,000 sq. ft. of call-center product built and occupied within the past six months in the East-West Corridor," he reports, "with another 320,000 sq. ft. either planned or already under construction."

In the O'Hare/Chicago International Airport submarket, a recently passed bill by the Illinois legislature allowing a land-based gambling casino in Rosemont "will have an impact on office developments and their locations," says Malm. Overall, "There is not much tenant movement between downtown and suburban Chicago," he says. "Most of the movement takes place among tenants in the suburban submarkets, usually as the result of acquisitions and/or mergers."

Robert J. Winter Jr., president and CEO of Itasca, Ill.-based AMLI Commercial Properties Trust, reports stong leasing in suburban Lake County, but also points out some warning signs indicating possible overbuilding in Chicago's suburbs.

For its part, AMLI hopes to take a bigger role in build-to-suit suburban development in 2000. AMLI is currently competing for five build-to-suit deals, where last year it competed for none. "As long as the economy stays strong, we'll see construction next year similar to last year's," Winter says. "But I would not put up a spec building today."

Motor City resurgence "In my 25 years in the industry, I've never seen this [Detroit office] market any stronger," says Steve Morris, principal of GVA Strategis. "Demand is far outpacing supply in virtually every submarket," he notes. "The strong automobile market in the past seven years has made its impact felt on all sectors of this market, taking space almost as quickly as it's built, while the financial services companies have also taken hundreds of thousands of sq. ft.," Morris adds.

General Motors' purchase of Renaissance Center and its headquarters move there was a major shot in the arm for downtown Detroit some three years ago, according to Morris. More recently, Compuware committed to an initial 500,000 sq. ft. for a headquarters facility in the mixed-use Campus Martius project, he reports. "Now is a good time for downtown landlords," adds Morris. In a market that is 15% vacant, rents have been increasing some 7% to 10% annually, he notes, with the price of entry into Class-A space now standing at $30 per sq. ft.

In Detroit's suburbs, Class-A space costs from $22.50 to $26 per sq. ft., according to Signature Associates vice president John Gordy. "Rental rates continue to rise, vacancies are dropping, absorption is positive and limited speculative construction is coming on line," he says.

Kansas City, Mo. The 44 million sq. ft. Kansas City, Mo., office market is healthy, according to Lawrence C. Glaze, president and CEO of Glaze Commercial Real Estate Advisors/ CRESA in Kansas City. "Kansas City has a broad-based economy," he notes, "with a lot of growth coming from within the market, as well as from companies coming here from smaller markets looking for a location in a bigger market that has a good labor force with a strong work ethic."

Vacancy for Class-A space is under 5% in all Kansas City submarkets, including the 15 million sq. ft. CBD, says Glaze. Rental rates for Class-A space run in the $20-plus per sq. ft. range throughout the office market.

On the new-development front, both speculative and build-to-suit construction are taking place here, according to Glaze. Of major impact is Sprint's construction of a $700 million, 3.9 million sq. ft. world headquarters, slated for completion in 2001. The telecommunications giant is scheduled to begin consolidating its operations into its new headquarters during mid-1999 as leases expire in its 60 buildings located in the Kansas City metro area.

Office outlook A strong domestic economy, a recovering Southeast Asia and stabilizing Latin American economies suggest that corporate earnings should rebound this year, according to the Summer 1999 issue of Grubb & Ellis' Market Trends. As a result, "Office leasing activity and absorption should rebound along with corporate earnings as companies reinstate the facility plans they put on hold last year when prospects for the economy and capital markets looked much dimmer." The report also notes that the amount of new construction will restrain rent increases for the remainder of the year, despite strong demand.

"The fundamentals of the office market look very good," says C&W's Stanton. "The investment outlook for CBD office is excellent, while suburban office is a 'slower grower' because of all the new construction that is underway - but that market is still in equilibrium."

"What we are experiencing now is a state of normalcy - a balanced market for office," says CMD's Schaller. "A lot of people haven't seen a balanced market like this in quite a few years, and they don't know how to handle it." In a stable market like this one, which has no broad-based buy or sell indications apparent, "People have to make buy and sell decisions based on their analysis and expectations for individual assets," says Schaller. "In other words, they have to act by their wits, rather than waiting for the market to tell them what to do."