Office construction spending up, but fading

The office building sector continued to look deceptively healthy — on the basis of year-to-date spending trends — right into the fall of this year. The value of new office building work completed through September 2001 was running 3.3 percent ahead of the total for the first nine months of 2000. But the market has been fading badly in recent months as job losses have mounted. In the wake of Sept. 11, fewer new projects are moving forward, although few have been canceled.

Service-sector layoffs and rising office vacancy rates have significantly reduced demand for new space since the spring. Following no over-the-year gain during both May and June, total July to September office construction spending was 11.9 percent lower than during the third quarter of 2000. This represented a sudden and dramatic reversal of fortune for the sector, as the first-quarter 2001 spending for office buildings had beaten the comparable year-earlier total by 21.7 percent.

Although the seasonally adjusted annualized spending pace for office construction actually increased by 2.9 percent between August and September, this surprising improvement was likely only a temporary blip in a longer-term downward trend. Even with the up tick, September's office spending was off 8.2 percent from three months earlier.

With the more pervasive economic slowdown, there's reason to believe that new supply has begun to exceed the level of new demand and that vacancy rates in most geographic markets will move higher between now and mid-2002.

Office building construction expanded by 17 percent last year following gains that averaged 16.6 percent over the previous five years. But, given the rapidly deteriorating market, office construction spending will likely plunge during the final three months of this year.