Office construction spending up, but expected to peak soon

August 11, 2010

Office construction spending was sluggish early in this business expansion, but then jumped 31% during the 15-month period ending in June. A further 18% gain is expected by the end of 2008.

The building surge is being fueled by a decline in office vacancy rates, according to Property & Portfolio Research, with rates falling from 17% to under 15%. Office rents also are rising, up 10% over the last 15 months. Low-rate rental contracts signed during depressed market conditions in 2002 are now being renewed at 10-20% higher rates.

Real estate investors see offices as an attractive market that offers positive net operating income and potential capital gains as office properties continue to increase in value. The office building boom will last several more years, although the growth pace will slow. Office construction starts through July are 38% higher than in same period last year, according to Reed Construction Data, but further gains should be modest. Net newly completed space this year will only be about two-thirds the amount completed at the peak of the last building cycle in 2002.

The rapid growth in demand for office space stems from the strong employment growth in office-based industries. Job expansion in finance, insurance, business, and professional services is more than twice as fast as in the rest of the economy, which typically happens at the mature end of a business expansion. Some financially marginal projects in the pre-bid stage will be cancelled as the boom ebbs. This process is already under way as investors become more nervous about risk, which leads them to raise financing rates, pull back money from real estate development, and demand higher equity participation from developers.

         
 

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