As published in Scotsman Guide's Commercial Edition, March 2010.
In this past December's column, we noted the havoc that the recession has wreaked on office properties across the nation. Judging from what we saw in the third quarter of 2009, office-market troubles are far from over.
Office properties had negative net absorption of 19.7 million square feet in the quarter, which marked the seventh-consecutive quarter that office properties registered occupancy deterioration. These figures imply a slightly deeper dip compared to the second quarter's 19.5 million square feet. By the third quarter, year-to-date negative absorption equaled 64.5 million square feet at the national level — roughly equivalent to the entire office inventory in the San Diego market.
Here is another way to interpret the data: Negative net absorption from the first quarter of 2008 to the third quarter of '09 was 106.5 million square feet. Positive net absorption for '06 and '07 was 107.9 million square feet. So in seven quarters, the recession has undone almost all additions to occupied space that occurred in the years when office rents peaked.
While completions slowed to a trickle in the third quarter, with less than 7 million square feet of new office space coming online, weakness in absorption pushed the national vacancy rate to 16.5 percent, 60 basis points greater than in the second quarter of '09. This represents a 280-basis-point year-to-year increase and a 400-basis-point jump in vacancy from the third quarter of '07. Then, office vacancies hit 12.5 percent, the lowest point in this cycle.
Vacancies are at a five-year high; the last time we saw vacancies in this range was at the end of '04.
Asking rents also decreased by 1 percent in the third quarter of '09, while effective rents dropped by 2.2 percent in that same time. These changes aren't as drastic as those seen in the first two quarters of '09. Looking at year-to-year figures, however, shows us how the decline in effective rents gained steam after the fall of Lehman Brothers in September '08.
The one-year effective-rent change of negative-8.5 percent is a magnitude unseen in almost 15 years. Landlords haven't been under such pressures to retain and attract office tenants since '95.
Compared to effective rents, asking rents have decreased at a lower rate. But this only indicates potential trouble down the line if conditions do not improve soon. Landlords only can give away so many concessions. At some point, they must decrease asking rents significantly to bring prospective office tenants in the door, even before negotiating concession packages.
We have yet to observe clear, systematic evidence that the office market is bottoming out and has begun to recover. Our outlook for office properties remains the same: There will be no recovery in vacancy levels and rent growth until mid- to late-2011, assuming that labor markets have recovered by late this year.
Victor Calanog, director of research at Reis Inc., writes a monthly column on property types for Scotsman Guide. As head of Reis' core economics team, he is responsible for data models, forecasting, valuation and portfolio services for clients in commercial real estate. Reach him at email@example.com. Dan Quan, director of quality control at Reis, contributed to this article.