Office vacancies starting to ease

The office vacancy rate in major metropolitan areas likely peaked at 16.5-17.0% earlier this year and is now subsiding slowly to under 16% by the end of the year. It could be as low as 12% by the end of 2004. Over the previous two years the vacancy rate nearly doubled and rents tumbled over 20% as employment in office-based industries fell 4-5%. At first, the vacancy rate will decline very slowly because new space is still being added about as fast as more office employees are being hired. The first new spaces to be occupied are empty offices and cubicles in buildings that are currently rented and being held for rehiring.

Office employment recovers late in a business cycle. The peak growth rate is when high margins spur new enterprises, rapid economic growth causes managers to hire ahead, and new hires are thrown at emergency tasks that can eventually be done with fewer people. This will not happen until 2005 in this business cycle, so the pace of growth in office demand will accelerate for more than two years. As a result the office vacancy rate will decline at a quickening pace as well.

Suburban va-cancy rates are 3.5 points above down- town rates because that was where most of the buildings being developed were located when the office market collapsed in 2001. The recovery of the office market will be a mirror image of the decline. Most of the new office demand will be suburban, so suburban vacancy rates will drop more quickly next year.

New York, Washington, San Diego, and Sacramento have the tightest office markets, with an 11% vacancy rate. New York has had its office supply painfully reduced by 9/11; the other cities are public administrative and military centers that escaped a direct hit from the recession but will be hurt by public spending cuts in the aftermath of the recession. Kansas City, Columbus, Dallas, Atlanta, Detroit, San Francisco, and San Jose have 21-22% vacancy rates. Office demand in these commercial and manufacturing centers is more cyclical and will recover more quickly than government centers.