Iffy Job Growth Curbs Office Real Estate

Investor's Business Daily

That supposed big drop in unemployment isn't filling up desks around the U.S. Empty office space still abounds from the recession — and paltry leasing activity is now blunting optimism for a broad-based office property recovery.

The jobless rate ducked from 8.1% in August to 7.8% in September, its lowest since early 2009. But the change arrived on the backs of workers coping with weak economic conditions: Seasonally adjusted, employment jumped by 873,000 — but 582,000 of the new positions were part-time jobs taken on to make a buck, Labor Department data show.

Characterizing office real estate demand as "very weak," property researcher Reis (REIS) says tenants nationwide leased nearly 5.45 million square feet in the third quarter this year, compared with just more than 5.33 million a year earlier and nearly 4.46 million a quarter ago.

"Until we get a meaningful pickup in employment, it's going to be an uninteresting recovery in terms of office demand and rents," said Alan Pontius, a managing director at property brokerage Marcus & Millichap Real Estate Investment Services.

"There are examples of some markets performing better than others," said Pontius, who oversees the office and industrial group. "But any way you slice it, you're talking about a national vacancy rate of 17%.

Cubicle QuandaryThe U.S. average office vacancy rate has inched down only 50 basis points since peaking in late 2010 and early 2011. It slipped 10 basis points from the second quarter to 17.1% in the third, according to Reis, and that was down 30 basis points from a year ago. Meanwhile the average asking rent nudged up 0.2% from the second quarter to $28.23 a square foot, a 1.4% hike from a year ago.

On the positive side, Reis said in its preliminary report on the third quarter that firms have now leased more space than they've vacated for seven straight quarters. But at best, office market fundamentals show only middling performance.

The dearth of new jobs is catching the blame. An average of some 146,000 jobs a month have been created in the first nine months of this year, according to the U.S. Bureau of Labor Statistics.

Events in Europe — such as debt crises and resultant austerity measures — have also fed uncertainty for months, says Asieh Mansour, a senior managing director of research for property brokerage CB Richard Ellis.

She adds that more recent worries include a slowing economy in China and the U.S. journey toward the Jan. 1 fiscal cliff. That's a concoction of higher taxes and cuts in federal spending that economists have warned could spawn a recession unless lawmakers and the president find a way to avert it.

"We're noticing that (those influences) are impacting the certainty of tenants, in terms of locking in leases and expanding into new space," Mansour said. "So leasing has slowed.

Micro ManagingAmid a continuing spirit of frugality, cost-conscious companies are packing more workers into smaller spaces — it's a fundamental shift in how they use their square footage. That could mute office absorption even if hiring strengthens, Mansour says. She notes that on average, an office worker today occupies about 190 square feet, down from 225 a few years ago.

"I think a lot of firms want to hit 150 square feet," she said.

The ho-hum recovery is perpetuating a split personality among office markets nationwide.

"There are certain markets that have had pretty good rent growth over the last year-and-a-half to two years," said Charles Malet, chief investment officer of San-Francisco-based Shorenstein Properties, which owns 21.5 million square feet of office space primarily in major coastal markets. "But there are plenty of others that just aren't seeing it. It's really a story of haves and have-nots.

Where The Jobs AreThe "haves" happen to be landlords in big coastal markets and elsewhere that have a higher concentration of technology and energy companies, he says. New York, San Jose, Calif., and Boston are typical of that group. Building owners in small markets with more diverse economies, or exposure to struggling sectors, are still challenged.

The average vacancy rate of 13.4% in tech-heavy San Francisco in the third quarter was 130 basis points lower than a year earlier, according to Reis. Meanwhile average asking rents there surged 4.1% to $40.54 annually per square foot, the biggest gain among the 82 office markets Reis monitors.

By contrast, the vacancy rate in Dayton, Ohio, increased 70 basis points year over year to 27.3% in the third quarter. Asking rents slipped 0.3%, to $14.47 a square foot.

Besides San Francisco, other markets with notable vacancy and rent improvements over the last year include Austin and Houston in Texas, and Seattle. But like Dayton, metro areas such as Colorado Springs, Colo., and Las Vegas have barely improved or even deteriorated.

Pontius says that unfortunately, technology and energy are the only sectors driving real office demand. That's the case even though occupations that typically fill offices, such as professional and business services, have posted job growth over the last several months.

"The gains just aren't meaningful enough to move the needle on a national average in many metros," he said.

'Burbs Brighten, A LittleOn an encouraging note, observers suggest that suburban office buildings are showing some life. Vacancy rates are still very high, but the average slid to 17.3% in the third quarter from 18% a year earlier, according to CB Richard Ellis (CBG). Leasing activity stayed consistent in the third quarter, Mansour says. (The property brokerage pegged the average downtown vacancy rate at 12.4% in the third quarter.)Offices in central business districts generally have higher occupancies over time than suburban properties, she says. But Mansour adds that in past recoveries, suburban office owners typically saw fundamentals improve before their downtown counterparts, as expanding but cautious small businesses sought cheap space.

That didn't happen this time because small businesses haven't added jobs, Mansour says. Instead, big publicly held corporations — along with companies that prefer downtowns — have driven leasing. Google (GOOG) is moving its trimmed Motorola Mobility unit's headquarters next year to downtown Chicago from the suburbs, for example.

Shorenstein has seen an uptick in tenant interest in its suburban office properties in Portland, Ore., Malet says, and over the past year occupancy in the buildings has climbed by about 5%, to over 80%.

"It's a pretty good bellwether of the economy — there are lots of little, local types of tenants — and it was completely dead for two years," he said. "It's not significantly better, but it is better."

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