Office boom past its peak, but still up

The surge in office development is ebbing, but office construction spending will expand 12% in both 2008 and 2009, on top of 19% gains experienced in the previous two years. 

While the value of office construction starts is up 27% year-to-date through October, monthly starts during the last four months have fallen below the late 2006/early 2007 peak. Rapid expansion of office-based industries, especially consulting, software, accounting, and insurance, is fueling the rising demand for office space. The pipeline of planned office projects is stuffed with the value of pending projects, triple the amount since the last building cycle bottomed out four years ago. An increasing share of these projects, however, will be substantially delayed or remain unbuilt because new office supply now matches office space demand, keeping the national vacancy rate at 14.8%.

Real estate investors still project high returns for office projects but expected returns have slipped from extremely high to above average over the last 18 months. Rollover leases updating 2002 rental rates are pushing up office rents more than 7% this year, but rental growth will slow in the next few years.

Rents are increasing rapidly in areas where rapid-growth, office-based industries are concentrated, including Boston, Los Angeles, New York, and the San Francisco Bay Area. Vacancy rates are now rising slightly and are likely to rise further in cities with the most severe housing market declines, including Atlanta, Dallas, Las Vegas, Los Angeles, Miami, Phoenix, Tampa, and Washington, D.C. Conversely, office vacancy rates are now declining in cities with relatively small housing market declines, including Charlotte and Raleigh, N.C., Houston, New York, San Jose, Calif., and Seattle. The residential mortgage problem also caused a 50 to 100 basis point rise in commercial mortgage rates.

Highest office vacancy rates (3rd quarter, 2007)

Atlanta 21.5%

Dallas 21.0%

Detroit 19.9%

Cleveland 19.1%
Columbus 18.5%

Lowest office vacancy rates (3rd quarter, 2007)

Honolulu 8.2%

New York 10.1%

New Orleans 11.4%

Washington, D.C. 11.5%

Salt Lake City 11.7%

Source: Property & Portfolio Research