Office market kicks into expansion phase

Fourth-quarter office market reports by CB Richard Ellis and the U.S. Census Bureau, which show decreases in office vacancies and increases in office construction spending, marks the beginning of at least a three-year period of expansion in the office market. The CB Richard Ellis quarterly survey reported that the national office vacancy rate fell to 15.6% at the end of last year from the peak rate of 16.8% in the third quarter. Suburban vacancies fell 1.4 points to 16.8% and the downtown rate dropped 1.0 point to 13.5%. The survey also reported that the square footage of office absorptions exceeded the square footage added from new construction for the first time in more than three years.

The vacancy survey is consistent with the Census Bureau report that fourth-quarter spending on office construction increased 4.2%. This was the second quarter-to-quarter gain after nine quarters of steep decline.

So far, office construction spending is only up 6% from the bottom of the office market recession, reached early last year, but spending is expected to rise 10% this year and 13% in 2005. Although spending is increasing, it will not match the expansion in demand, which means vacancy rates will continue to decrease by several points a year.

Demand is now being driven by rising employment and stabilizing rental rates, with small increases expected after midyear and much larger gains in rates anticipated for next year.

Office vacancy rates shrank the most last quarter in suburban New York, Boston, and San Jose. The highest vacancy rates (22-24%) continue to be in the manufacturing centers: Dallas, Columbus, Atlanta, Kansas City, and Detroit. The lowest rates (10-12%) are still in administrative centers of Washington, D.C., New York, San Diego, and Sacramento, as well as Los Angeles, the main port for trade with Asia. The largest office markets, less dependent on a few industries, have significantly lower vacancy rates than the smaller regional markets.