National – The United States office market ended the year on a high note with the vast majority of markets displaying occupancy growth and rental gains, but a number of the usual suspects are missing from the top ranks. Instead, historical “secondary markets” like Phoenix, Raleigh-Durham, Salt Lake City, and Miami are topping the list alongside the likes of San Francisco and Silicon Valley. Meanwhile, non-Central Business District (CBD) markets in metro areas with high concentration of technology tenants are coming back to peak levels as well, such as Cambridge, Mass., and Seattle’s Eastside, outpacing their respective CBD markets.
Fueling the nationwide demand for office space, naturally, is the bustling U.S. economy, which has propelled office fundamentals to their strongest levels in more than six years. JLL’s Q4 2014 U.S. Office Outlook shows that nationwide, net absorption increased by 36.7% from 2013, ending the year at 54.7 million sf. Meanwhile, more than 80% of U.S. office markets experienced rental rate growth over the course of the year, while the total office vacancy rate ticked down a percentage point from year-end 2013 to 15.6%. For leases larger than 20,000 sf, the numbers are even more compelling: Nearly 50% of all large leases experienced occupancy growth, contributing to the second quarter in a row that posted double the rate of growth the U.S. has experienced at any other point during the recovery.
“The U.S. added nearly 3 million jobs to the economy in 2014. Our unemployment rate is the lowest it has been since the second half of 2008. Meanwhile, corporate profits and consumer spending are strong, encouraging the business sector’s confidence in continued expansion,” explained John Sikaitis, managing director of research at JLL.
Indeed, new construction in 2014 was more than 68% higher on a per-sf basis than in 2013. Much of it continues to be concentrated in the CBDs of large metro areas. The nationwide average for vacant space in the CBDs is only 12.7% compared to an overall office vacancy rate of 15.6%t. It is the tightest markets that are seeing the most new development, like Midtown and Downtown New York, Downtown Seattle, Philadelphia, and San Francisco. But a number of non-CBD markets are busy with shovels in the ground as well. The biggest outlier is Houston. Other top-performing non-CBDs, especially those with a strong tech and life science presence like Cambridge, have become such sought-after office markets that current demand outpaces available space by multiples of two or even four. The demand in East Cambridge, in particular, is so strong that it’s having a ripple effect, helping to drive leasing activity in Boston’s CBD.
“Demand in Cambridge is nearly four times greater than existing supply,” noted Peter Bekarian, managing director in JLL’s Boston office. “The vacancy rate is at 7.7% and falling. The new construction under way will not be enough to slow the growth of rental rates significantly. Rents have soared over the past year, rising 14% over the course of the year. While average asking rents for office space in East Cambridge are now just shy of $59 per sf, some buildings have already achieved rents in excess of $70 per sf.”
Meanwhile, the traditional top-tier markets like Boston, Midtown New York, Chicago, and Los Angeles are tightening, but still haven’t approached the cyclical peak. Washington, D.C.’s office fundamentals, on the other hand, are only just coming out of the red for the first time in four years due to diversification of demand to tech, media, and creative, while its suburban markets, dominated by government contractors, are still in decline.
A Watchful Eye on the Future
While the current picture is rosy for the U.S. office sector overall, the real estate industry will be closely watching several recent economic developments that could slow momentum. In spite of enormous employment gains, labor force participation is still the lowest it has been in more than three decades, and low energy prices will be disconcerting for the otherwise bustling Southern and South Central regions of the country.
“There are certainly several economic factors along these lines that the real estate industry will have to bear in mind when making near-term growth estimations. But overall, the forecast for 2015 and into 2016 is the strongest it has been in more than 10 years,” Sikaitis concluded.
This article was originally printed in Real Estate Times.