Office vacancy rates continue to decline

The national office vacancy rate declined 0.3% to 16.6% in the final quarter of last year, according to Property & Portfolio Research. Further declines of about 0.5–0.7% are expected in both 2006 and 2007, as the absorption of office space exceeds new supply in the early stage of the expansion of office construction.

The recent drop in vacancy rates was driven largely by tenants leasing for their anticipated space needs in the next few years, with a small contribution from an increase in jobs in office-based industries that caused immediate space needs. This business optimism is fragile but appears to be sustainable.

As a result, real estate investors currently see offices as the most attractive property market, promising the highest investment returns. Office rental rates have increased marginally since last spring, with 3–5% annual rent increases anticipated in 2006–07. Also, the asset value of buildings continues to rise with increasing net operating income and steady long-term credit rates.

The bright office investment environment supports a pickup in office project starts in 2005–07 and strong increases in office construction spending in 2006–08. The value of private office starts increased 32.2% last year and was 22.6% higher in January and February than in the first two months of last year. This growth pace will slow quickly but will be high enough to generate a 10% gain in office construction spending this year and 22% next year.

The forecast projects that the vacancy rate at the end of 2007 will be slightly above the long-term average of about 15%, ensuring that starts and spending will continue stronger than average into 2008 and perhaps beyond.

U.S. cities with the highest and lowest office vacancy rates
(Q4/2005 vacancy rate %)