Office Markets Beginning to Show Signs of ‘Bottoming Out’
Although the economy finished the quarter on a sluggish note, leasing activity remained relatively robust through the April-June period, helping to stabilize market fundamentals after a prolonged period of weakening. Both Canadian and U.S. vacancies rose during the quarter although the latest increases were relatively muted. Demand was mixed, with U.S. markets only recording mildly positive absorption while Canadian markets registered more substantial growth. With both the U.S. and Canadian economies posting relatively robust growth in the second quarter and a further stabilization in the labor market, leasing markets are expected to continue improving, albeit only in small increments and not dramatically before mid-2011 at the earliest.
The second quarter reaffirms our view that the first half of 2010 was a period of transition from dramatically rising vacancies and falling rents to more modest movements in both and a possible reversal in the coming quarters. Calling into question the idea of a swift recovery, however, is a noticeable downshift in the economy and a still stubbornly high unemployment rate. More encouraging, however is the six month long gain in private sector employment, suggesting the recent improvement in office leasing activity may be sustainable beyond a quarter or two.
U.S. office vacancy rate up again, but only marginally. The U.S. national office vacancy rate moved slightly higher during the second quarter, moving just 2 basis points (100 basis points equals one percent) higher. This marked the eleventh consecutive quarterly increase, which left the overall vacancy rate at 16.34 percent at the end of the quarter and possibly marking a cyclical high. U.S. office vacancies are now back to levels last recorded during the first quarter of 2004. During Q2 the Downtown vacancy rate increased 14 basis points to register 15.01 percent while suburban vacancies decreased 3 basis points to total 16.94 percent. Canadian vacancy rates were mixed with central business district (CBD) vacancies rising 37 basis points to 7.10 percent while suburban vacancies decreased 7 basis points to 8.93 percent.
Office tenants are back to leasing space, although barely enough to register. After nine consecutive quarters of negative absorption, the U.S. office market registered a slight increase in occupied space. Second quarter absorption came in at 2.7 MSF (million square feet). This was a significant improvement from a year ago, when 25.1 MSF was returned to the market, and up from the first quarter when occupied space contracted by 5.1 MSF. While it is becoming increasingly clear most companies have finished disposing of excess space, there is little evidence to suggest many will be expanding any time soon. Canadian markets also recorded an increase in occupied space during the quarter with absorption totaling 1.2 MSF.
Office rents mixed, CBD up, suburban down. After almost two years of falling lease rates, CBD rents managed to eke out a small increase during the quarter, rising by 1.0%. Suburban rents, however, extended their downward path, falling by 1.3%. Downtown Class A lease rates finished the quarter at $38.53 per square foot while suburban asking rents registered $26.24 per square foot. Year-over-year CBD rents were down 6.4% while suburban rents were down 4.1%. Office rents in Canada moved higher during the quarter with CBD quoted rents increasing 2.6% and suburban rents up 1.6%.
Office development resumed downward trend. Second quarter office completions totaled 11.1 MSF, a modest drop from the first quarter when construction totaled 13.4 MSF, and down from a year ago when 16.3 MSF was completed. Construction activity continued to decline with Q2 development under construction falling to just 29.2 MSF, compared with 31.2 MSF at the end of the quarter first quarter and well below the 120 MSF underway at midyear 2008. Construction is expected to dwindle as the year progresses and with the exception of just a few build-to-suits, new office development will be largely absent from the U.S. office landscape by year-end.