IRVINE AND SILICON VALLEY, CALIF. — The U.S. office real estate sector’s fundamentals appear to be stalling after years of slow recovery, as vacancy rates remain stubbornly high despite a healthy labor market and growing national economy, according to Ten-X’s latest U.S. Office Market Outlook.
Ten-X cited Reis data that shows the national vacancy rate for office space has held steady at 16 percent for three consecutive quarters. Vacancies are now 40 basis points lower than a year ago and 160 basis points below their cyclical peak, but they remain well above levels seen during the last economic cycle.
Source: Ten-X
Only 70 million square feet of new supply has been occupied during each of the last two quarters. Rent growth has hit a similar slump, with effective rents edging up just 0.4 percent in the third quarter of 2016 and 2.8 percent over the past year — the slowest annual growth since mid-2014.
The downturn in office fundamentals comes despite a strong labor market that continues to add jobs and a steadily expanding economy. Low unemployment, consistent payroll gains and rising wages should offer a boost to overall demand for office space, though the national economic picture is marked by stark differences among markets in different regions, according to Ten-X Research.
Ten-X models project moderate improvement in the office sector as the current economic expansion advances, despite long-term headwinds driven by the rise of shared offices, cloud computing and remote teleconferencing. Ten-X expects cyclical factors to drive vacancies to a low of 15.3 percent in 2018 before regressing to roughly 17.6 percent during a downturn scenario in the following two years.
The report projects that rent growth will emerge from its cooling period to post roughly 3 percent increases per year in 2017 and 2018, reaching a peak of over $27 per square foot before contracting as vacancies begin to rise again.
“After a long, gradual recovery following the last recession, the office sector has seen its progress slow significantly over the last year,” said Peter Muoio, chief economist of Ten-X. “The resilient economy makes it likely that the current malaise [in the office sector] is only temporary. Overall demand should increase as employers continue to add jobs over the next two years, which bodes well for investors’ long-term prospects in most areas of the country.”
Overall investment sales volume in the sector totaled $35 billion during the third quarter of 2016. Effective rents are up 2.8 percent and have now surpassed their pre-recession peak, while cap rates rose 20 basis points to average 6 percent.
The Ten-X forecast also indicates that the top markets where investors should buy office assets are Portland, Ore.; Oakland, Calif.; Palm Beach, Fla.; Orange County, Calif.; and Miami. Growing economies led by strong demographics and consistent job growth are fueling robust demand for office space in these markets, concentrated in Florida and the West Coast.
The report’s top sell markets are Houston, Cleveland, suburban Maryland, Memphis and Milwaukee. Weakening labor markets, which have reduced demand for office space and significantly slowed absorption rates, are undermining these cities.
Ten-X is an online real estate transaction marketplace and the parent company to Ten-X Homes, Ten-X Commercial and Auction.com. To date, the company has sold more than 260,000 residential and commercial properties totaling more than $43 billion. Ten-X is headquartered in Irvine and Silicon Valley, Calif., and has offices in key markets nationwide. Investors in the company include CapitalG (formerly Google Capital) and Stone Point Capital.
— Staff Reports