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Peaking office rents are becoming a problem in many markets. Tenants have shown they’re willing to expand, but as high demand pushes rents to record levels amid Brexit and the upcoming election turmoil, experts say tenants might have an excuse to delay decisions until 2017.
Across the globe, trophy office rents increased 2.4 percent from mid-year 2015 to mid-year 2016, according to a recent report from commercial real estate services firm CBRE, with rents in the Americas region up 2.3 percent. “Since inflation is low, the growth in prime office occupancy costs is significant for both users and investors,” said Richard Barkham, global chief economist for CBRE, in an official statement.
However, corporations showed more caution during the first half of this year, and rent growth might moderate significantly by December compared to last year, according to Julia Georgules, vice president of research with real estate services firm JLL. The firm recently published a multi-market report of “skyline,” or trophy office space. “Tightening conditions mean that tenants won’t see a reprieve for a few more quarters, but we do anticipate rents in the skyline will begin to moderate,” Georgules said in a statement.
Real estate services firm Savills Studley recently released a global prime office market ranking by occupancy costs, with London on top at $256.11 per sq. ft. London is followed by five other foreign cities, including Hong Kong ($241.90 per sq. ft.) and Tokyo ($202.25 per sq. ft.). Only six U.S. cities are listed in the top 20, including some usual suspects such as New York and San Francisco.
For the most part, office property fundamentals remain as solid as they were in mid-2015, according to Pat McGrath, senior managing director at Savills. Vacancy continues to drop nationwide, and most cities are still benefitting from pent-up demand for space. Lending on new projects remains controlled. However, going toward 2017, the national outlook is starting to look choppy, McGrath notes.
“If I was going to bet as a tenant, if I was being pitched a lease restructuring in the threat of future increases, I’d probably wait,” he says. “Unless a firm is looking to repurpose their offices to gain new talent, I’d wait. I think you’re going to start seeing an increase in concessions.”
Here are the U.S. cities that made the top 20 list for annual gross occupancy cost per sq. ft. for prime office space:
New York made it into the top three most expensive cities in the U.S., with an average cost per station of $15,931. It placed as the sixth most expensive city globally.
The major technology companies such as Google and LinkedIn have been expanding their footprints in the Bay Area, limiting the availability of large blocks of space and illustrating the trend of movement to urban centers, according to JLL. Recently delivered office buildings in the market, such as 535 Mission St., 222 Second St. and 350 Mission St., were 100-percent pre-leased, and demand is still high.
However, some experts say trophy rents won’t get to $100 per sq. ft. here. A recent commercial real estate survey completed jointly by Allen Matkins and UCLA Anderson shows that developers have become more pessimistic about rental rate growth and vacancy rates, with many believing that rent growth will change to loss by 2019. A recent research report by RBC Capital Markets LLC blamed the expected slowdown on tech tenants reaching their limit on high rents while also trying to stay competitive to keep top talent. “We expect leasing activity will soon moderate off the historically strong pace,” according to the report. “Executives remain largely cautious and are preparing for a more difficult capital raising environment.”
Maryland suburbs/D.C. metro area made the list with a score of 54.3. There are 11.5 million sq. ft. of life sciences space in the region, with a vacancy rate of 3.2 percent and asking rents of $24.23 per sq. ft.
One of the outliers on this list, Chicago should experiences continuing rent increases, due to limited supply of high quality space, according to JLL. Properties that are part of the Chicago “skyline” have seen asking rents increase 11.8 percent since the low point of 2009. Like Los Angeles, Chicago has also experienced a tech frim influx into the West Loop, such as Google expanding into the Fulton Market district, and McDonald’s recent announcement it would return its headquarters to the city’s downtown.
The downtown L.A. trophy market is still at least one to two years away from a peak in rents, according to JLL. However, the Century City market is tightening fast, with full-floor availabilities declining by 50 percent in 2015. Tenants will continue to have limited alternative options in that market, JLL researchers note. Google’s expansion into the city has had a positive effect on demand, McGrath says. “Now all the tech companies want to expand there,” he notes.
Brokers at JLL admit that even though Houston’s asking rents remain near all-time highs, tenants at trophy properties will gain more leverage this year and into 2017. It’s common knowledge that there’s been a slowdown in leasing in Houston, says McGrath. “It’s hard not to see the impact that oil price fluctuations have on that market,” he says. A recent CBRE report tried to accentuate the positive by noting that subleasing is up, and construction is down to 4.2 million sq. ft., with more than 51 percent directly preleased. Still, even class-A rents are dropping in Houston, according to CBRE.
