Despite Booming Jobs Market, Improvement Proves Choppy for Office Sector, Says Ten-X
IRVINE, CALIF. — Recovery of the national office sector has failed to gain traction as completions outpaced net absorption for the fifth consecutive quarter, according to the latest U.S. Office Market Outlook report by Ten-X Commercial.
“While the national market shows an office segment that is struggling, a closer look at various local markets shows several different reasons underlying this general malaise,” says Peter Muoio, chief economist for Irvine, Calif.-based Ten-X. “Strong markets with fast-growing economies saw significant development and are now grappling with increased supply, while weak markets continue to languish due to their struggling local economies.”
Shrinking office space requirements for employees is at the core of market pricing softness, according to Ten-X. Employers are fitting more workers into open floor plans, enabling more employees to work remotely. Cloud computing reduces the need to spend physical space on filing cabinets and servers. These trends have caused the strong correlation between rising employment figures and the strength of the office market to weaken.
“In most markets, technological innovation is an additional factor that acts as a headwind for the office sector,” adds Muoio.
Top buy/sell markets
Naturally, some markets are more promising than others. The top five markets in which investors should consider buying office properties are Nashville, Kansas City, Washington, D.C., Sacramento, Calif. and Oakland, Calif., according to Ten-X. These markets have strong overall economies and specific industry sectors generating job growth. Unemployment is at 2.8 percent in Nashville and the population is expanding at twice the national rate, according to Ten-X.
Milwaukee, suburban Maryland, Chicago, Austin and Baltimore are the top five markets where conditions might cause investors to consider selling their office properties, continues Ten-X. These markets have either weak economics with tepid job growth and population outflows, or have booming growth leading to overzealous development activity and oversupply. In Milwaukee, employment growth has been persistently weak since 2016, as the education, healthcare and wholesale trade sectors have continued to disappoint, says Ten-X.
Forecasting future market conditions
In the first quarter of 2018, U.S. office vacancies inched up to 16.5 percent from the low to mid-16 percent range where they have been mired for nearly three years, says Ten-X. As a result, rent growth has lost steam and is now about 2 percent, down from the more robust growth rate of 3.8 percent measured in 2015.
Ten-X incorporates cyclicality into its forecast model with a stress test in 2019-2020, a scenario meant to estimate recessionary conditions rather than serve as a temporal prediction.
Absorption is expected to fall in 2019 and 2020, lifting vacancies to 18.7 percent nationwide. While conditions are expected to improve with the onset of a recovery in 2021, vacancies will finish at 18.4 percent, nearly 200 basis points above their current level, according to Ten-X projections.
Rent growth is not likely to recover enough to hit the pace seen earlier in this cycle, says Ten-X. After climbing in 2018, effective rents are forecasted to fall 2.1 percent during the 2019-2020 stress test scenario. Rents are expected to resume growth in 2021 as fundamentals improve, and finish on par with current levels.
“While every submarket and individual asset tells its own story, it’s clear that the overall picture for the office sector is decidedly bleak,” says Muoio.
— Kristin Hiller