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Commercial Department: Property TypeCast: July 2018

 

Property TypeCast

The tech sector is still driving the office market

c_2018-07_property_typecast_chart.jpgWhen it comes to evaluating the commercial real estate market in terms of risk and return, investors could easily rank the asset classes by most preferred (multifamily, industrial) and least preferred (retail). In fact, the one asset class that gets the least scrutiny, it seems, is the office market — which tends to be perennially overlooked because of its slow rent growth and slower occupancy growth.

Nationally, as of this past first quarter, the office vacancy rate was 16.5 percent, little changed from 17.1 percent in 2014. In the same time frame, the average effective rent has increased 12 percent, for an average of 0.7 percent per quarter. At $26.67 per square foot, the average effective rent is only 8.4 percent above the previous peak in 2008.

These sluggish national statistics, however, obscure the widening gap between the stronger metros and the weaker ones. There has always been a divide between the better metros and those at the bottom, but it appears that the gap between the two sets is widening, and one variable is driving that wedge: tech-related growth.

First, the bad news: As many as 33 metros posted a year-over-year decline in office occupancy as of first-quarter 2018. Most of these declines were small, less than 0.6 percent, but 33 metros is more than the 2017 quarterly average of 26 metros showing year-over-year declines in occupancy.

Similarly, 17 metros saw a decline in office employment over the past year, and not surprisingly, many of these 17 metros line up with the ones that recorded an office-occupancy decline.

Now for the good news: Despite the underwhelming occupancy statistics, year-over-year rent growth was either flat or positive for every metro as of this past first quarter. This may strike many as odd, but it reflects a general confidence in the economy. More significantly, some 15 metros saw strong office-occupancy growth of 2 percent or more over the same period. They also posted office-employment growth of 3.8 percent or more as well as effective rent growth of 3 percent or more. 

What do these and the other markets with the highest office-occupancy growth have in common? Not only do they have an above-average concentration of tech employment, but healthy growth in tech employment.

In San Francisco, which recorded 3.4 percent annual growth in office occupancy as of first-quarter 2018, employment growth in computer-systems design — a catch-all term for tech employment — was up year over year by 6.8 percent as of this past first quarter. In Seattle, it was 5.3 percent over the same period, and in San Jose, California — the leading market nationally in office-occupancy growth — tech employment expanded by 3.2 percent. The same tech-industry sector grew 5 percent in Boston and 3.6 percent in New York City over the same period.

Boston saw office-occupancy growth of 1.1 percent and effective rent growth of 4.2 percent.  New York City still boasts the lowest office-vacancy rate nationally, at 8.3 percent. Its office market saw occupancy growth of 0.6 percent and effective rent growth of 1.6 percent. New York is expecting to add close to 5 million square feet of new office-space completions this year, but much of it is preleased.

In short, there is much to be optimistic about with respect to the office market. The technology sector is still poised to add more jobs, although it has and may continue to face labor shortages in some markets. And many mid-tier cities show healthy office-occupancy growth, including Austin, Texas; Memphis, Tennessee; Oklahoma City; and the North Carolina metros of Charlotte and Raleigh-Durham. These metros also have seen healthy growth in tech and other office-based industries. When it comes to finding opportunities, don’t get fooled by the dull national statistics. Look at the metros with expanding tech sectors. It pays to do the research.


 

Victor Calanog is chief economist and senior vice president for research at Reis Inc. (www.reis.com). He writes a monthly column on property types for Scotsman Guide. Calanog and his team of economists are responsible for data models, forecasting, valuation and portfolio services for clients in commercial real estate. Reach him at victor.calanog@reis.com. Barbara Byrne Denham is an economist in the research and economics department at Reis Inc. She previously served as chief economist at Eastern Consolidated and is a Ph.D. candidate at New York University, where she has studied economics, monetary theory and game theory. Reach her at barbara.denham@reis.com.

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