Strong U.S. Office Market Continues to Cool but Select Upside Remains

U.S. office market fundamentals remain at their strongest point in the cycle, with peak occupancy and record rents. Yet, there is little doubt that the market has been cooling.

The national office vacancy rate has been virtually static for more than a year. Rents are still rising but the pace of appreciation is modest and slowing. Likewise, absorption is still positive but Q1 2017 was relatively quiet and activity was concentrated in suburban markets. Office space under construction rose for the third successive quarter in Q1 2017, while investors continue to chase higher returns — leading to an increased focus on suburban and second-tier markets.

KEY TAKEAWAYS

  • Absorption Falls but Looks Set to Improve: National office absorption was minimal in Q1 2017. Tenant move-outs, renewals and downsizing continue to be the primary factors, but there is also a supply shortage in some markets. Stronger GDP growth is anticipated for the remainder of the year, which should underpin healthier demand.
  • Vacancy Has Troughed: The U.S. office vacancy rate has been almost flat for more than a year and is now at the same level as seen in the peak of the previous cycle.
  • Rent Growth Is Stalling: Average office asking rates grew by less than 1% in Q1 2017. However, Class A rent appreciation is stronger. Among the major markets, Manhattan and Chicago are outperforming. The strongest growth is centered among a handful of secondary markets.
  • Speculative Space Is on the Way: Office construction remains elevated and deliveries are front-loaded. While pre-commitments still dominate, the share of unleased space is rising. This presents potential negative connotations, particularly for the larger West Coast markets.
  • Buyers Are Still Out There: Office sales volume fell in Q1 2017 but remains healthy. Investor strategies continue to shift toward suburban and second-tier markets that provide higher yields, but there are still buyers for trophy central business district product. There is little upward pressure on capitalization rates, but rising interest rates are a concern.