Amid the uncertainty this year has brought, the Memphis office market’s fundamentals have continued to be stable through the end of the second quarter of 2020. Net absorption posted negative gains, recording 53,389 square feet of negative net absorption this quarter. While occupiers seeking rent relief was of minimal consequence, the steady demand allowed the total vacancy rate to decrease 80 basis points from the first quarter to 14.5 percent in the second quarter of 2020. Office tenants are continuing to pay rent on time, with less than 4 percent attrition on overall rent collection, which is no different than normal.
In Memphis and the Southeast overall, leasing activity in this latest quarter was driven almost exclusively by near-term lease expirations. Similar to years past during various cycles of economic slowdowns, we are again seeing the overwhelming majority of new lease prospects limited to those companies who “have to” move, versus those companies that “want to” move. This is understandable, given the myriad of hardships caused by the pandemic and the limitation it has imposed on travel, group meetings and overall workplace usage. In fact, many companies have paused to assess their future space utilization, and whenever possible are delaying long-term decision making until the post-COVID-19 future becomes clearer.
Ron Kastner,
Senior Vice President,
CBRE
Nevertheless, companies are still needing and wanting office space. Employers spent much of the second quarter having devised the required workarounds to office closures and are now assessing its impact on employee productivity. Most companies are lamenting the loss of camaraderie and creativity that a traditional shared office setting can provide, while others are discovering significant cost savings and opportunities to identify overlap, as the result of successful work-from-home platforms.
This does foretell a wave of change coming when leases are renewed and office footprints will be re-evaluated. In either case, we do expect these changing sentiments to drive growth and continue to lead the market to a swift recovery. We also expect the coming quarter to be more telling as to the long-term effects that COVID-19 will have on Memphis.
Hot submarkets
The Northeast and Southeast submarkets are the current hot spots for office leasing activity in Memphis. This activity can be attributed to the abundance of parking availability in these two submarkets and also the lack of sizable vacancy within the core submarkets of East Memphis and Downtown, both having experienced several consecutive quarters of significant leasing activity.
The Northeast submarket led absorption numbers in the first quarter of 2020, posting over 20,000 square feet of positive net absorption. Another notable lease transaction occurred in the Northeast submarket where Stratas Foods leased 22,864 square feet at 7000 Goodlett Farms Parkway.
The Southeast saw significant new leasing with large office leases being signed at Southwind Office Center with FedEx Freight taking 73,756 square feet and Lenox Park leasing 50,000 square feet.
Office rents rise
Thanks to a tight market and accelerating construction costs, the Memphis office market is seeing increasing rental rates. In the second quarter of 2020, the weighted average asking rental rate increased to $18.77 per square foot, a 12-basis point increase quarter-over-quarter.
Tenant renewal rates are climbing and approaching current asking rent levels, and this equilibrium should result in more tenant movement in the marketplace. In general, newly delivered office space over the next five years will require rents from the mid-to-high $30s per square foot when top-market rents are currently closer to $30.
Relocations, construction
Overall, a lack of new product over the past 10 years has caused a lag in supply of Class A space, which in turn has produced fewer location options for tenants and lower vacancy rates. Tenants seeking new or better office configurations are the main driver of relocations and new office construction. What previously fueled this demand for new office design was employee compaction, and this will likely be replaced by employee separation.
However, every company has different needs, which influences the ratio of open spaces and amenities versus dedicated meeting rooms and private offices. Also, limited Class A office space in Downtown and in East Memphis is spurring investors to rehabilitate existing buildings, but even those conversions are diminishing rapidly.
With limited new supply in the construction pipeline and continued demand for quality office space, average asking rents should remain stable. However, the extended outlook for vacancy rates is expected to increase as companies modify their office environments during lease renewal negotiations. Despite the chaotic effects of these past six months, we see that most companies are resilient and are poised for a strong recovery.
— By Ron Kastner, senior vice president, CBRE. This article originally appeared in the July 2020 issue of Southeast Real Estate Business.