Office vacancies edge lower, starts surge

Offices became the most attractive market to commercial real estate investors late in 2006 and will hold that position for at least another year. The demand for office space is expanding faster than supply in most major markets. The national vacancy rate fell to 15% in the first quarter of 2007 from 16% a year earlier. As a result, office rental rates are up nearly 6% in the past year with a similar rise projected for the coming year.

Completion of new office space will increase sharply following a surge of new starts from about a year ago. Reed Construction Data reported that the value of office construction starts in April was 71% higher than the previous April, and year-to-date starts are 60% higher than the same period in 2006. This surge in new supply will keep the vacancy rate from declining much further, and will begin to trim rental rate increases later this year. However, the amount of space now under construction or soon to bid is not enough to keep developers from raising office starts in the next two years. Office construction spending increased 27% in the past 12 months and will rise a similar amount by the end of next year.

Houston, Phoenix, New York City, Boston, and San Francisco had the biggest increases in rented office space in the six months through March. In the tight New York City and San Francisco Bay area markets, rents were pushed up 10% or more and spurred a burst of new office starts. But 13% vacancy rates kept rent growth under 10% in Houston and Phoenix, and kept the increase in office starts relatively modest. Boston’s 19% vacancy rate kept rental rate growth near the national average and kept office starts near zero.

U.S. cities with the highest and lowest office vacancy rates
(2007 Q1 vacancy rate %)