First-Look: U.S. Office, Warehouse Markets Begin Year On Strong Note

As preliminary first-quarter data and new forecasts for the rest of 2014 and beyond begin to roll in, it's clear that demand for office and industrial space continue to improve steadily in most major metros, despite fairly plodding employment growth, geopolitical tensions with Russia and some of the most severe weather in two decades blanketing many parts of the U.S. 

Eight out of 13 major metro markets saw office vacancy rates decrease and average asking rents increase in the first three months of 2014. 

Preliminary CoStar data for multitenant office buildings 50,000 square feet and larger shows the highest first-quarter absorption since at least 2007, the end of the last boom cycle, and the highest occupancy since mid-2009 following the throes of the Great Recession. 


"The U.S. economic recovery is continuing to fuel demand for office space nationally, with relatively little new space coming on the market," said Art Jones, senior managing economist. "Landlords are seeing the pendulum of pricing power shift in their direction and are able to raise rents modestly in most major markets." 

From here, analysts expect two more years of strong performance for real estate and the broader economy is in the offing. The latest multi-year outlook covering 2014 through 2016 from the Urban Land Institute (ULI) and EY predicts steady economic growth in the U.S., along with sustained investment demand from real estate capital markets and continued improvement in both CRE fundamentals and the housing sector. 

The semi-annual ULI/E&Y Real Estate Consensus Forecast is based on a survey of 39 of the industry’s leading economists and analysts, including Hans Nordby, managing director, and Shaw Lupton, senior real estate economist, with CoStar's Property and Portfolio Research (PPR) analysis and forecasting unit. The consensus prediction from the survey conducted between Feb. 19 and March 14 is that CRE transaction volume will reach a decade-high $430 billion by 2016, exceeding the record-setting volume of 2006. 

The report shows a marked increase in optimism over the last survey conducted in October. However, recovery across the globe is still uneven and a good size list of risks remain, cautioned Howard Roth, global real estate leader for EY, during a presentation Tuesday. 

Among those risks: High global unemployment, high government debt, pressure from deflation in advanced economies, weak domestic demand, capital flow volatility in emerging markets and the potential impact from tapering of economic stimulus by the U.S. Federal Reserve. 

"Still, all signs point to a continued gradual improvement in both the economy and real estate market fundamentals," Roth noted. 

Rising Office Rents Expected to Continue

Survey respondents foresee healthy growth in office rental rates through 2016, increase by 3% in 2014, 3.9% next year and 3.6% in 2016. 

For now, office market performance is steady but not spectacular. In the first quarter of 2014, U.S. office markets absorbed 12 million square feet, up 63% from the same quarter a year ago. However, the U.S. vacancy rate remained unchanged at 15.4% as 10.5 million square feet of new space was delivered in the quarter, according to a first-quarter analysis by Cassidy Turley. Average asking rents rose 2.1% compared to a year ago to $22.30 per square foot. 

After three years in which modest increases in office demand coupled with a smattering of new supply have repeated again and again, something like a broken record, absorption is catching up with supply. More than 50% of the country is now experiencing consistent upward movement in rents, Chief Economist Kevin Thorpe said. 

In addition to the abnormally harsh winter which kept consumers' hands in their coats and stymied business expansion, temporary factors that slowed growth in the first part of the year included a flight of reserve capital out of emerging market currencies (which rattled the equity markets), and Cold War style geopolitical tensions with Russia, Thorpe added. 

"As we enter spring, the economic data in the U.S. should resume the stronger trajectory that we observed in the second half of last year," Thorpe said. "Likely, we will see much stronger demand numbers in the office sector for the remainder of the year." 

According to CBRE, Atlanta and Seattle led the U.S. in vacancy declines, each with a vacancy rate drop of 60 basis points during the quarter. Technology firms once again led demand improvements in Seattle, and the story was more broad-based in Atlanta, with tech, health care and service firms leading demand. 

A bit surprisingly for a market that suffered along with other housing bust markets a few years ago, Phoenix led the nation with a 3.9% increase in average asking rents, followed by San Francisco at 3.3%, as large blocks of space in both markets are in short supply. 

Warehouse Building Boom on Horizon

U.S. warehouse markets also experienced healthy activity in the first quarter, with fundamentals continuing to recover on the back of strong economic drivers, and demand notably strong in big-box space driven by e-commerce, logistics and food facility users. 

"With trade, industrial production and private inventories all expanding, early numbers suggest the industrial sector is continuing to recover strongly," said Jared Sullivan, senior economist. 

Atlanta had the largest drop in its industrial availability rate (space that is actively being marketed and available for tenant build-out within 12 months), falling 100 bps to 14.9%, amid demand in the home building, logistics and consumer products sectors. 

Average asking rents grew in nine of the top 12 warehouse markets with only one market showing a decline. 

After years in the freezer, new commercial construction is slowly thawing. Growing demand for bank construction and development financing, combined with an easing of underwriting standards, should provide developers with capital for good projects. 

Lending standards for CRE construction and land development loosened by -8.1% in the first quarter, followed by multifamily (-6.7%) and non-farm nonresidential construction (-6.6%), according to Federal Reserve Senior Loan Officer Opinion Survey data analyzed by Morgan Stanley. 

Borrower demand for CRE development loans, meanwhile, jumped more than 28% in the first quarter, while edging down to still-solid 23% growth for multifamily projects. 

Nationally, 65.4 million square feet of new office buildings were under construction at the end of the first quarter, up 31% from the same quarter a year ago, Cassidy Turley said. 

Though office development nationally remains constrained, increased activity was evident in markets like Houston and San Francisco, which each reported deliveries of about 1.2 million square feet, CBRE reported. 

With U.S. industrial market experiencing a tightening supply, especially in the highly competitive big-box market, both build-to-suit and speculative warehouse construction activity is increasing, in most cases to pre-recession levels, the report said. 
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