End is near for five-year office market construction drought

Continued 3.5%-plus economic growth will push vacancy rates down and rental rates up enough to boost office construction spending about 30%, including 8–10% higher costs, from spring 2005 to the end of 2006. Further strong expansion will extend into 2007. While the projected turnabout is very modest compared to previous office construction booms, it will be enough to end the five-year decline in the office construction market late in 2005.

Office construction spending, adjusted for inflation, increased about 5% in the last half of 2003, but this gain has since been eroded by inflation. Nominal spending for office construction has been essentially unchanged in the last 16 months during a period of rapid cost inflation. The resulting unusually low amount of new space added to market supply has contributed as much to slowly falling office vacancy rates as has the modest amount of new demand absorbing available space.

The national office vacancy rate fell slightly to 17.4% early in 2005 and has likely fallen further to about 17% by the end of the summer. Property & Portfolio Research reports declining or steady vacancy rates in almost every major market. Vacancy rate trends range from little change in Chicago, Cleveland, Philadelphia, and Tampa, to rapid decline in Washington, D.C., Northern California, Portland, Ore., and Raleigh, N.C.

Generally, the highest vacancy rates are in electronics and heavy manufacturing centers, while the lowest rates are in metro areas dominated by service industries, including government agencies. Servicing rapidly growing trade with Asia has kept the office vacancy rate in the Los Angeles area, including Orange County and Riverside, well below average.