USA Office Markets Update – What Now?

Arthur R. van der Vant

According to the REALTORS Commercial Alliance Report the terrorist attacks on the World Trade Center and Pentagon, two of the country’s most prominent addresses, provided a dramatic ending to the near picture-perfect market conditions of the last three years.

Key market gauges had been marching in the wrong direction since the office market peaked nationally at the end of 2000, so seeing the high-profile office space literally going up in smoke had a special poignancy for real estate practitioners and service providers.

But despite the physical and psychological devastation, practitioners are optimistic about the office sector over the long term.

That doesn’t mean it will be business as usual for the country’s office sector. With crippled airline, hotel and other travel-related industries, helping to push the economy into recession and the country’s lawmakers shifting their focus from domestic issues to a war against terrorism – with potential curbs on trade and immigration – office market conditions are sure to be bumpy.

Nationally, several negative trends continue to drive the office sector into a near-term slowdown. As of mid-2001, the national average vacancy rate was around 10 percent, up more than 140 basis points since the second quarter of 2000. At the same time, absorption had stagnated. It plummeted to a negative 3.7 million square feet in the first quarter of 2001, then worked its way back up to about negative 800,000 square feet in the second quarter, then settled at zero in the third quarter.

What’s more, rental growth has been sitting at zero on a national average basis since the second quarter of 2001, driven down from an average 10 percent annual increase in large part by stark drops in tech-heavy markets such as San Francisco.

All the figures are based on NAR analyses of data from 54 major markets around the country.

Under-girdling all this bad news is a breathtaking increase in sublease space – largely a parting gift of the dot-com and telecommunications companies whose growth fueled so much of the demand for office space in the first place. Sublease space totaled 60 million square feet in the first quarter of 2001, up by a third over the fourth of 2000 according to Grubb & Ellis.

Commercial practitioners in New York City and Northern Virginia are upbeat about the office market prospects in their areas, but they say there are stiff challenges ahead in the aftermath of the terrorist attacks.

In New York City, close to 20 million square feet of office space was lost. Commercial practitioners stepped up to help displaced office tenants find new space cheaply and quickly. On the day after the attack, Bruce Mosler, president of Cushman & Wakefield, announced that his company would help its displaced clients at no charge. Shortly after, the Real Estate Board of New York City issued a memo asking practitioners to help displaced tenants without fees and owners to hold rents stable.

But the long-term market impacts are hard to discern. In New York, the office vacancy rate, at about 4 percent, was one of the tightest in the country at the time of attack. There was about 14 million square feet of vacant space at the time of attacks, but practitioners say much of that wasn’t suitable for tenants from the financial district.

In Northern Virginia, the Pentagon attack destroyed 4 million square feet of office space and displaced an estimated 4,800 employees, according to news reports. The federal government has since found space for most of its displaced people, mainly at the Crystal City area of Arlington, which borders the Potomac River across from Washington, D.C. The office vacancy rate in Arlington stood at about 7.5 percent in late September. But that’s expected to drop and the market to tighten now, practitioners say.

Amidst all this doom and gloom are strengths that will keep office lease transactions turning at a steady – albeit reduced – clip into 2002.

For starters, speculative development has stayed in check. That has helped keep vacancies from hitting the high double-digit levels that plagued markets in the late 1980s.

Another big help has been interest rates, which dipped below 7 percent in the third quarter of 2001. The low rates have enabled developers to refinance their property debt, leaving them in a better position to withstand softer conditions. Even the growth of the sublease market has an upside. The needs of tech companies made it all but impossible for „old economy” companies to get the space they wanted, especially when their needs called for lots of square footage. Now big blocks of space are becoming available, opening the door for new transactions. Many tenants see the sublease space as an opportunity to upgrade their quarters. Tenants normally seeking Class B space can get into Class A space, so they’re upgrading.

The trade-off, of course, is downward pressure on rents, but even in market with the largest rent drops, such as San Francisco, levels have yet to come down to where they were just 18 months ago.

* Source: National Association
of Realtors Commercial Report

Arthur R. van der Vant,
President & CEO

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