Office rents decline by record margin in '09

Victor Calanog, director of research, Reis Inc.

As published in Scotsman Guide's Commercial Edition, July 2010.

While "less negative" may be "the new positive," it is difficult to understate the pressure that office properties have endured since the recession began. In 2009, demand for office space contracted in a devastating fashion, driven largely by the millions of jobs the economy shed in the year.

Just as in the third quarter of '09 (sctsm.in/3997), occupied space dwindled for office properties in the fourth quarter, which witnessed 16 million square feet go vacant. Quarterly negative net absorption decelerated somewhat throughout the year, mimicking the job-loss trend for '09, according to the U.S. Bureau of Labor Statistics. Asking rents also decreased 1.1 percent, and effective rents declined 1.9 percent between the third and fourth quarters of '09.

Although the quarterly office rent changes are less than in the first two quarters of the year, the annual effective-rent decline of 8.9 percent represents the largest such drop Reis has seen in 30 years of tracking it.

The largest effective-rent decline between the fourth quarters of '08 and '09 also came in the largest U.S. office market — New York, whose 19.8-percent drop is the largest in the city since Reis started tracking it in 1981. That's more than twice the 9.3-percent drop it saw in the year following Sept. 11.

Between the third and fourth quarters of '09, New York's effective office rents decreased by 5.3 percent, also the largest decline among cities and double that of San Diego, Dallas and others. Effective rents in New York are now $44.69 per square foot. This wipes out all gains since its peak year of rent growth in 2007.

Sure, quarterly and annual figures for deterioration in office fundamentals are bleak in New York and elsewhere. But they're a bit expected — and consistent with previous projections in April '09 (sctsm.in/3524) and this past August (sctsm.in/3699). We expected this year to be one of the most-difficult years for office properties on record, given the depth and magnitude of the recession. It is.

Our outlook for the office sector's recovery — when vacancies decrease and rent growth turns positive — remains the same: We do not expect vacancies to begin declining until late 2011, and it may take another year for positive rent growth to resume. This year will continue to witness increasing office vacancies and negative rent growth. But if the overall economy and labor markets continue to recover, as they did this past spring, the magnitudes of decline should be strictly less than what we recorded in '09. Stability and a few months of growth, however, are necessary before we expect demand for office space to resume at a pace that would allow office landlords to begin raising rents.

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 victor.calanog@reis.com. Kyle McLaughlin, senior analyst for Reis' eonomics department, contributed to this article.