Roughly 25% of the nation’s leased office space is set to expire in 2011 or 2012 and tenants are moving into the driver’s seat in negotiating new terms with landlords already pressured by a glut of vacant space. That’s the conclusion of a new report by Encino, Calif.-based real estate services firm Marcus & Millichap.
As leases come due, many firms will move to smaller blocks of space than they currently occupy. The downsizing comes against the backdrop of an economic recovery that is expected to make “slow, choppy progress” through the remainder of 2010 and during the early months of 2011, according to the report.
Researchers warn that risks such an another slide in the housing market and eroding consumer confidence persist, however they conclude that the chance of a double-dip recession remains unlikely. The consumer sector accounts for 70% of U.S. gross domestic product (GDP), but it will remain hampered by tight credit and high unemployment over the next several quarters, according to the outlook.
The nation’s office vacancy rate rose 10 basis points to 17.4% in the second quarter, the 11th consecutive period in which vacancy rates increased, according to Marcus & Millichap. The vacancy rate has spiked nearly 500 basis points from the cyclical low point, the highest rate since 1993.
Law firms shrink demand
Across the country, at more than 400 sq. ft. per employee, the decrease in legal employment represents a drop in space demand of more than 30 million sq. ft. but the losses are not limited to law firms. Employment in the financial sector is projected to contract for the fourth consecutive year in 2010, weighing on space demand well into the economic recovery.
In major cities, a number of trophy properties could be affected by the downsizing. In addition to being large users of office space, legal and financial firms often occupy some of the most expensive Class-A space. As these users vacate space, managers will encounter challenges achieving current rental rates when new tenants move in, according to Marcus & Millichap.
As the vacancy rate climbed, negative net absorption totaled 1.4 million sq. ft. in the second quarter. The figure actually represents an improvement in the pace of contraction of tenant demand. Since the recession began, tenants have returned an average of 14.6 million sq. ft. of office space per quarter.
Big cities shine
In cities where new tenants are securing space, they are gravitating to central business districts.
Positive net absorption in the central business districts totaled 2.6 million sq. ft. in the second quarter, while tenant demand remained soft in the suburbs.
Low interest rates and uncertainty surrounding future tax rates will likely fuel sales velocity in the second half, but, ultimately, net operating income gains will be needed to deepen the pool of active buyers.
The greatest increases of investment activity occurred in primary markets where occupancy has shown the most improvement.