Strong U.S. Office Market Continues to Cool but Select Upside Remains Stephen Newbold, National Director of Office Research | USA U.S. Research Report OFFICE MARKET OUTLOOK Q1 2017 U.S. office market fundamentals remain at their strongest point in the cycle, with peak occupancy and record rents. Yet, with few exceptions, there is little doubt that the market has been cooling. The national office vacancy rate has been virtually static for more than a year. Rents are still rising but the pace of appreciation is modest and slowing. Likewise, absorption is still positive but Q1 2017 was relatively quiet and activity was concentrated in suburban markets. Meanwhile, office construction remains elevated and the share of uncommitted space is rising. This implies the vacancy rate is due to increase, though the anticipated GDP-driven pickup later in the year should absorb some of this vacancy. Finally, investment sales volume fell in Q1 2017 as buyers continue to chase higher returns, leading to an increased focus on suburban and second-tier markets. Key Observations > Absorption Falls but Looks Set to Improve: National office absorption was minimal in Q1 2017. Tenant move-outs, renewals and downsizing continue to be the primary factors, but there is also a supply shortage in some markets. Stronger GDP growth is anticipated for the remainder of the year, which should underpin healthier demand. > Vacancy Has Troughed: The U.S. office vacancy rate has been almost flat for more than a year and is now at the same level as seen in the peak of the previous cycle. > Rent Growth Is Stalling: Average office asking rates grew by less than 1% in Q1 2017. However, Class A rent appreciation is stronger. Among the major markets, Manhattan and Chicago are outperforming. The strongest growth is centered among a handful of secondary markets. > Speculative Space Is on the Way: Office construction remains elevated and deliveries are front-loaded. While pre-commitments still dominate, the share of unleased space is rising. This presents potential negative connotations, particularly for the larger West Coast markets. > Buyers Are Still Out There: Office sales volume fell in Q1 2017 but remains healthy. Investor strategies continue to shift toward suburban and second-tier markets that provide higher yields, but there are still buyers for trophy central business district (CBD) product. There is little upward pressure on capitalization (cap) rates, but rising interest rates are a concern. Summary Statistics | Q1 2017 U.S. Office Market Vacancy Rate 12.2% Change From Q4 2016 (Basis Points) -10 Absorption (MSF) % of Markets With Positive Absorption 3.2 54% New Supply (MSF) 18.7 Under Construction (MSF) 112.9 ASKING RENTS PER SQUARE FOOT PER YEAR Downtown Class A $47.64 Change From Q4 2016 Change From Q1 2016 +10.7% +3.5% Suburban Class A $29.39 Change From Q4 2016 Change From Q1 2016 +13.2% +1.9% Market Indicators Relative to Prior Period Q1 2017 Q1 2018* VACANCY NET ABSORPTION CONSTRUCTION RENTAL RATE** *Projected **Rental rates for current quarter are for CBD; rent forecast is for metrowide rents.
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Strong U.S. Office Market Continues to Cool but Select Upside Remains Stephen Newbold, National Director of Office Research | USA
U.S. Research Report
OFFICE MARKET OUTLOOKQ1 2017
U.S. office market fundamentals remain at their strongest point in the cycle, with peak occupancy and record rents. Yet, with few exceptions, there is little doubt that the market has been cooling. The national office vacancy rate has been virtually static for more than a year. Rents are still rising but the pace of appreciation is modest and slowing. Likewise, absorption is still positive but Q1 2017 was relatively quiet and activity was concentrated in suburban markets.
Meanwhile, office construction remains elevated and the share of uncommitted space is rising. This implies the vacancy rate is due to increase, though the anticipated GDP-driven pickup later in the year should absorb some of this vacancy. Finally, investment sales volume fell in Q1 2017 as buyers continue to chase higher returns, leading to an increased focus on suburban and second-tier markets.
Key Observations
> Absorption Falls but Looks Set to Improve: National office absorption was minimal in Q1 2017. Tenant move-outs, renewals and downsizing continue to be the primary factors, but there is also a supply shortage in some markets. Stronger GDP growth is anticipated for the remainder of the year, which should underpin healthier demand.
> Vacancy Has Troughed: The U.S. office vacancy rate has been almost flat for more than a year and is now at the same level as seen in the peak of the previous cycle.
> Rent Growth Is Stalling: Average office asking rates grew by less than 1% in Q1 2017. However, Class A rent appreciation is stronger. Among the major markets, Manhattan and Chicago are outperforming. The strongest growth is centered among a handful of secondary markets.
> Speculative Space Is on the Way: Office construction remains elevated and deliveries are front-loaded. While pre-commitments still dominate, the share of unleased space is rising. This presents potential negative connotations, particularly for the larger West Coast markets.
> Buyers Are Still Out There: Office sales volume fell in Q1 2017 but remains healthy. Investor strategies continue to shift toward suburban and second-tier markets that provide higher yields, but there are still buyers for trophy central business district (CBD) product. There is little upward pressure on capitalization (cap) rates, but rising interest rates are a concern.
Summary Statistics | Q1 2017 U.S. Office Market
Vacancy Rate 12.2% Change From Q4 2016 (Basis Points) -10
Absorption (MSF)
% of Markets With Positive Absorption
3.2
54%
New Supply (MSF) 18.7
Under Construction (MSF) 112.9
ASKING RENTS PER SQUARE FOOT PER YEAR
Downtown Class A $47.64 Change From Q4 2016 Change From Q1 2016
+10.7%+3.5%
Suburban Class A $29.39 Change From Q4 2016 Change From Q1 2016
+13.2%+1.9%
Market IndicatorsRelative to Prior Period
Q1 2017
Q1 2018*
VACANCY
NET ABSORPTION
CONSTRUCTION
RENTAL RATE** *Projected **Rental rates for current quarter are for CBD; rent forecast is for metrowide rents.
increase among the major markets occurred in Houston, where vacancy rose by 2.9%. Although downtown office markets still enjoy lower vacancy than the suburbs, the gap has narrowed over the past 12 months. Downtown vacancy rose from 10.2% to 10.5%, while suburban vacancy fell from 13.3% to 13%.
Net absorption fell for the second successive quarter in Q1 2017 to 3.2 million square feet, down from 12.9 million square feet in Q4 2016. Suburban markets accounted for 90% of the Q1 2017 absorption total.
The lower absorption is partly the result of a lack of large block availability as well as tenant move-outs to occupy pre-leased space. However, renewals and downsizing also continue to have an impact. Tenants are very cost-conscious and continue to seek ways of occupying space more efficiently. A footprint reduction of 10%–20% upon renewal is becoming the standard, and there are instances where the reduction has been significantly higher.
2 U.S. Research Report | Q1 2017 | Office Market Outlook | Colliers International
U.S. Job Growth Trends | 2-Month Moving Average
Source: Bureau of Labor Statistics
Economy Off to a Slow Start in 2017, but Expected to Strengthen
The U.S. economy slowed in Q1 2017 with annualized GDP growth of 1.2%. Stronger, if unspectacular, growth is anticipated in the short-to-medium term. The first-quarter GDP numbers are typically the weakest of the year, and the consensus view is for economic growth of around 2% for 2017 as a whole.
Along with post-election uncertainties, the low GDP growth in Q1 2017 likely restrained demand. However, other economic indicators — such as rising income growth, increased spending and greater global economic growth — point to upside going forward. Job growth remains solid with the U.S. economy adding an average of 178,000 jobs per month in the first quarter — albeit 10% lower than the post-recession average.
Vacancy Flat but Absorption Faltering
The U.S. office vacancy rate fell marginally in Q1 2017, dropping 10 basis points to 12.2% — providing further evidence that vacancy has plateaued. Since the beginning of 2016, vacancy has stayed within a 20-basis-point range and is now at the same point as at the peak of the prior cycle in Q3 2007, when the rate bottomed at 12.2%.
Some 30% of U.S. metro office markets now have a sub-10% vacancy rate. Raleigh/Durham and Nashville are the tightest, at 6.4% and 6.8% respectively in Q1 2017. Although the markets may now be turning, tech-heavy metros — such as Austin, Portland, San Francisco and Seattle — still have some of the lowest vacancy rates nationwide.
On an annualized basis, vacancy fell in just under 60% of metro markets over the 12 months leading up to Q1 2017. The biggest
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YOY Change in Vacancy-3.0% 3.0%
YOY Change in Metro Vacancy - Q1 2017
Portland, OR0.3%
Seattle-Puget Sound, WA-0.9%
San Francisco Bay Area, CA0.4%
Sacramento, CA-1.0%
Greater Los Angeles, CA-0.1%
San Diego, CA-1.0%
Phoenix, AZ-0.8%
Denver, CO0.8%
Minneapolis-St. Paul, NM0.8%
Chicago, IL0.9%
Kansas City, MO-KS-1.6%
Dallas-Ft. Worth, TX0.2%
Austin, TX-0.4%
Houston, TX2.9%
Tampa Bay, FL-2.4%
South Florida-3.6%
Orlando, FL-2.5%
Atlanta, GA0.5%
Charlotte, NC1.1%
Cincinnati, OH-0.8%
Columbus, OH-0.1%
Raleigh-Durham, NC-1.4%
Washington, D.C.-0.6%
Baltimore Metropolitan
Area0.0%
Philadelphia, PA-0.3%
Detroit, MI-2.4%
Cleveland-Akron, OH-1.2%
Pittsburgh, PA-0.3%
New York City Metro-0.1%
Boston, MA1.3%
Top 30 Metros: Year-Over-Year Change in Metro Vacancy | Q1 2017
Although overall downtown absorption was almost nil, relocations to urban cores persist as companies seek to be near their target labor pools. Notable Q1 2017 examples include Reebok’s relocation from a suburban campus to Boston’s Seaport area and GE Healthcare’s consolidation in downtown Chicago.
Rent Growth Is Slowing Sharply
While two-thirds of the metro markets that Colliers tracks saw an increase in office rents in Q1 2017, the pace of rent growth was minimal. First quarter rent appreciation in the U.S. — across all classes of space — was a mere 0.6%. Annual rent growth over the 12 months ending Q1 2017 was down to 3.4% from 5.4% at year-end 2016, taking overall rates to an average of $29.05 per square foot.
Average Class A asking rates in Q1 2017 stood at $47.64 per square foot in downtown markets and $29.39 per square foot in the suburbs, representing a quarterly increase of well under $1 per square foot in both locations. On an annualized basis, Class A downtown asking rates increased by 3.5% as of Q1 2017 compared to 1.9% in suburban markets — down from the 12-month growth rates in Q4 2016 of 4.1% and 2.7% respectively.
Manhattan and San Francisco have by far the highest Class A downtown asking rents at $79.47 per square foot and $75.25 per square foot respectively. However, the gap is widening with Manhattan posting the stronger growth among the two in Q1 2017. Bay Area downtown rent growth has shifted to the East Bay (Oakland) where — with Class A rates at a $30-per-square-foot discount relative to its expensive neighbor — rates rose by 3.9% over the quarter compared to only 1% in downtown San Francisco.
On a regional basis, the highest suburban rents remain concentrated in the West, where Class A asking rents are more than 20% above the U.S. average — led by the suburban San Francisco
Bay Area markets, including Silicon Valley. Orange County saw the highest quarterly rent appreciation of all U.S. suburban markets, with growth of 5.8% in Q1 2017. Over the 12 months leading to Q1 2017, there were no markets outside the West that saw double-digit percentage increases. Suburban Class A rent growth in the Midwest and Southern regions underperformed during this period at 1.7% and 1.2% respectively.
3 U.S. Research Report | Q1 2017 | Office Market Outlook | Colliers International
YOY Change in CBS Class A Rent - Q1 2017
YOY Change in Rent-10.0% 10.0%
Portland, OR-0.8%
Seattle-Puget Sound, WA3.6%
San Francisco Bay Area, CA3.6%
Sacramento, CA13.0%
Greater Los Angeles, CA1.9%
San Diego, CA6.4%
Phoenix, AZ6.1%
Denver, CO-1.0%
Minneapolis-St. Paul, NM1.9%
Chicago, IL7.9%
Kansas City, MO-KS2.9%
Dallas-Ft. Worth, TX3.6%
Austin, TX10.3%
Houston, TX-2.5%
Tampa Bay, FL7.5%
South Florida3.7%
Orlando, FL0.8%
Atlanta, GA7.4
Charlotte, NC5.1%
Cincinnati, OH-1.1%
Columbus, OH-3.1%
Raleigh-Durham, NC12.4%
Washington, D.C.3.8%
Baltimore Metropolitan
Area4.1%
Philadelphia, PA3.4%
Detroit, MI18.8%
Cleveland-Akron, OH-2.2%
Pittsburgh, PA5.6%
New York City Metro3.8%
Boston, MA0.2%
Top 30 Metros: Year-Over-Year Change in CBD Class A Rent | Q1 2017
Top U.S. Office Leases | Q1 2017TENANT ADDRESS MARKET SF TENANT INDUSTRY
21st Century Fox**
1211 Avenue of the Americas Manhattan 777,000 Media
Oracle 2300 Cloud Way Austin 550,750 Technology
Federal Communications
CommissionSentinel Square III Washington,
D.C. 473,000 Government
News Corp.* 1211 Avenue of the Americas Manhattan 444,000 Media
Royal Bank of Canada* 200 Vesey Street Manhattan 402,807 Financial
Services
*Renewal**Renewal/Expansion Sources: CoStar, Colliers International
Absorption (MSF) New Supply (MSF) Vacancy Rate (%)
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%
Speculative Construction Set to Test West Coast Markets
The volume of office space under construction has risen to 113 million square feet, up slightly from 110 million square feet at the end of 2016. Of this, 45 million square feet are underway in downtown markets and 68 million square feet are under construction in the suburbs.
Four markets continue to dominate the construction picture, accounting for almost half of current activity. The San Francisco Bay Area leads with 19.5 million square feet underway, followed by Dallas and Washington, D.C. (including Northern Virginia and Maryland), which both have more than 11 million square feet being built. New York rounds out the top four with 10.3 million square feet under construction.
Following 18.7 million square feet of deliveries in Q1 2017, the majority of space under construction (55% of total) is set for completion in the remainder of this year. While most major construction starts are predicated upon achieving a pre-commitment of at least 50%, speculative development is on the rise in select pockets of core cities.
This is most prevalent on the West Coast, centered in Los Angeles, the San Francisco Bay Area and Seattle, where leasing traction is lower than anticipated and some projects are starting to come online this year. West Los Angeles offers a striking example with 90% of space underway yet to lease. Accordingly, expect the vacancy rate to rise in these metros by late 2017.
Investors Remain Active Although Deal Volume Falls
In Q1 2017, national office sales volume fell by 12% over the previous quarter to $27.7 billion. This alone is not cause for major concern as the volume remains robust, but there are signs that pricing is peaking. The first quarter tends to be the low point of the year for investment activity, as portfolios are reassessed and strategies reviewed. The Q1 2017 total was the fourth-highest first-quarter total on record. A 33% fall in the dollar volume of portfolio sales contributed to the Q1 2017 fall-off.
Office cap rates have essentially bottomed. Average U.S. office cap rates stood at 6.7% in Q1 2017, compared with 6.6% one year earlier. The Q1 2017 cap rate for CBD markets is 5.7% compared to 5.6% in Q1 2016, while rates were 7.1% and 6.9% in the suburbs at the same points in time.
Suburban assets are accounting for a larger share of deal volume as investors search for higher yields. This is also increasing the focus on secondary markets. Austin, Phoenix and Kansas City all recorded single-asset sales of $150 million and above in Q1 2017.
However, demand for top-quality CBD assets is still strong, driven by investors who look to the long term. All but two of the 10 largest acquisitions in Q1 2017 by price were in major CBD markets. In the first quarter’s largest transaction, GIC acquired Deutsche Bank’s headquarters at 60 Wall Street in Manhattan for $998 million, or $645 per square foot. Boston and Manhattan both had transactions priced at more than $1,000 per square foot in Q1 2017.
4 U.S. Research Report | Q1 2017 | Office Market Outlook | Colliers International
Under Construction Quarterly Totals
Source: Colliers International
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Top U.S. Office Sales | Q1 2017
ADDRESS MARKET SF PRICE BUYER
Deutsche Bank HQ, 60 Wall Street* New York 1,612,000 $988,000,000 GIC
10 Saint James Boston 824,637 $673,000,000 Mori Trust
Vertex Pharmaceuticals HQ* Boston 1,133,723 $540,000,000 Barings
Fan Pier Boston 515,000 $447,000,000 Deutsche AWM - PF Pension ^
HBO HQ, 1100 Avenue of the Americas New York 344,000 $370,000,000 Brookfield - Swig
Company ^
* Partial Interest Sale^Joint Venture PurchaseSource: Real Capital Analytics
Cross-Border Investment in the U.S. | Q1 2017
COUNTRY # OF PROPERTIES TOTAL VOLUME*
Singapore 4 1,895Canada 33 1,432.8
South Korea 4 929.2
China 116 882.5
Japan 3 843.3
Denmark 4 584.2
Israel 2 357.5
Other 13 580.5
Total 179 7,505
* Volume in MillionsSource: Real Capital Analytics
5 U.S. Research Report | Q1 2017 | Office Market Outlook | Colliers International
Supplemental Data: Largest 20 MarketsLandlord and Tenant Conditions
Source: Colliers Q1 2017 office survey. Tenant-landlord assessment reflects conditions as of Q1 2017.
Landlord and Tenant Conditions(Largest 20 Markets)
