US Office Rentals Show A Decrease in Demand

Posted On Friday, 04 April 2008 02:00 Published by
Rate this item
(0 votes)
Businesses in the US are pulling back on renting office space, a signal that the economic bad times are hitting landlords and that business hiring is likely to remain weak

Demand for office space dropped for the first time since the economy emerged from its downturn earlier in the decade, according to first-quarter data from Reis Inc., a New York research firm. "Any sense of immediacy among companies to sign a lease was put on the back burner," says Sam Chandan, chief economist for Reis. "What became the dominant issue is the uncertainty in the overall economic outlook."

The rate of vacant office space nationwide increased to 12.8% from 12.6% in the previous quarter. Companies took less space even as real-estate owners added to the supply, according to Reis. That is still well below the 16.9% rate it hit in 2003 following the technology bust. It isn't expected to get as bad this time, because developers have been less aggressive about building new space.

Still, Reis's data, which is pulled from buildings in the 79 largest office markets, bodes poorly for the economy overall. Office vacancies are strongly correlated to job growth. Companies plan for office expansion when they are confident of adding new employees. That isn't happening.

The leasing slowdown also will likely exacerbate the decline in the construction of new commercial space, an area that propped up GDP growth last year. The Commerce Department Monday reported that February was the third straight month of decline in spending for private, nonresidential buildings. Patrick Newport, an economist with Global Insight, predicts a "pretty hard landing" though not as bad as after the 2001 recession when construction ground to a halt for several years.

The weakest office markets have taken a direct hit from the residential real-estate typhoon. Markets in Arizona, California, Nevada and Florida all showed signs of distress, with empty buildings and falling rents as housing-related industries such as construction and mortgage lending close shop. Office-market weakness has come as local unemployment rates ticked up those markets.

"The home builders have totally vanished," says David Flynn, a commercial real-estate broker at Lee & Associates Inc in Las Vegas. "That was a big piece of our economy, so that was a big piece of our demand," he says. Companies such as Countrywide Financial Corp. and others who have shrunk operations have put more than 500,000 square feet of empty office space -- or enough to seat 2,500 workers -- on the sublease market there. Rents fell 0.3% there in the first quarter.

Even New York, a market that was a landlord's paradise a year ago, has slowed as financial firms such as Bear Stearns Cos. and Citigroup Inc. lay off workers. The vacancy rate stood still at 5.6% after several quarters of consistent drops. Brokers say companies are skittish about taking on new real estate.

"People are fearful they will make two mistakes," says Peter Hennessey, New York head of tenant brokerage firm Staubach. "One is that the economic environment will harm their business, and they won't need the space. The second is that they go 'Oh, my goodness, we just paid 20% more than we had to....' Those combined, are making everybody sit on their hands."

The news is especially bad for investors who bought and financed office buildings during a short-lived frenzy in 2006 and 2007. At the time, tycoons paid top dollar expecting quick rent growth would cover the outsized debt payments. That strategy now seems to be unraveling.

The default rate on so-called commercial mortgage-backed securities that financed many office-building deals in recent years remains near historical lows. Nevertheless, the value of the securities has fallen sharply because of the credit crunch, and the recent leasing statistics aren't going to help, because they could presage a rising default rate.

Overall, companies occupied 1.7 million fewer square feet of office space in the first quarter compared with the previous quarter. While that is a slight decline compared with the nearly four billion square feet of supply, it is the first downward movement since 2003. The worst recent demand drop in the decade was in the quarter of the Sept. 11, 2001, attacks when tenants fled 47 million square feet.

There are some bright spots. "The energy markets are booming," says Ric Clark, chief executive of office company Brookfield Properties. Houston topped the list of 79 markets that Reis surveys in terms of rent growth, up 3.5% last quarter. Denver, Tulsa and Oklahoma City also fared well. Among the major markets hurting, Detroit saw rents drop 0.7% and led the nation with the highest vacancy rate -- 21.8%, up 0.8 percentage points.

Rental rates nationwide rose in the first quarter 1.5%. But rents generally lag the overall market, as landlords resist price cuts until there are clearer signs of pain. Markets that are deeper in economic malaise caused by the housing crisis are already in their second quarters of rent-price drops, including Fort Lauderdale, Las Vegas, and Orange County, Calif.

Publisher: Wall Street Journal
Source: WSJonline

Please publish modules in offcanvas position.