HOUSTON—A recent office analysis shows a strikingly vulnerable national office sector with vacancies that have remained essentially unmoved in the past two years and rent growth slowing to its weakest pace in five years. These were the findings from data cruncher Ten-X Commercial in its latest US office market outlook, including the top five sell markets for office properties.
Markets that recovered this cycle are struggling with increased supply while left-behind markets that saw limited improvement, remain weak. While 26 different regional markets had four-year projections downgraded by Ten-X in this most recent analysis, there were no markets in which the four-year prospects improved, highlighting the widespread nature of the sector's vulnerability.
Houston, San Francisco, Memphis, Baltimore and Suburban Maryland are the top markets where conditions might cause investors to consider selling office properties. These markets have either recorded tepid office job growth this cycle contributing to high vacancy rates, or had strong economic recoveries leading to more new office supply than the market can digest.
Houston is extremely vulnerable because its fundamentals have been weak in recent years, projected to continue sliding in the short term. Per Reis, vacancies have been climbing throughout the cycle and have reached an all-time high of 19.5%. In Ten-X's projected downturn scenario, vacancies are to pop nearly 300 basis points in 2019 to 2020 while rents will likely drop 5% in aggregate. Most alarming, rents will take on additional declines at the start of the new cycle in 2021.
“Houston has struggled in recent years due to wavering net absorption, slowing rent growth and rising vacancies. Residential displacement and damage to Houston's housing stock as a result of Hurricane Harvey make the apartment market outlook extremely volatile and unpredictable,” Matt Schreck, quantitative strategist of Ten-X Commercial, tells GlobeSt.com. “Our four-year forecast tentatively calls for a 1.8% average annual NOI decline over the long run, with the potential for volatile swings in the near term.”
US vacancies in the third quarter of 2017 were unchanged in the past year, at 16.1%. However, vacancies are projected to rise to 18.3% in 2021 after a modeled recessionary period in 2019 to 2020. Office rent growth slowed to the 1% range in 2017 overall, the slowest pace since 2012.
Despite US office employment growth this cycle that has surpassed the pace of previous economic expansions, demand remains lackluster. Since 2010, technology and workstyle changes have reduced office space per worker by approximately one third to just 150 square foot per worker today, a trend that has defined this cycle and left the US office segment oversupplied.
“Even with the prolonged nature of this economic cycle, demand for office space has been limited, leaving the segment extremely vulnerable,” said Ten-X chief economist Peter Muoio. “At this point, regional nuances are getting lost. Our 'heat map' gives a graphic portrayal of the performance of the office segment, and it clearly depicts a sector that is faced with considerable risk.”
Ten-X Research expects annual rent growth to edge up to 2% in 2018 from 1.5% last year. However, the modeled recession in 2019 to 2020 will push office rents to contract about 2.5% for two years.
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Lisa Brown
Lisa Brown is an editor for the south and west regions of GlobeSt.com. She has 25-plus years of real estate experience, with a regional PR role at Grubb & Ellis and a national communications position at MMI. Brown also spent 10 years as executive director at NAIOP San Francisco Bay Area chapter, where she led the organization to achieving its first national award honors and recognition on Capitol Hill. She has written extensively on commercial real estate topics and edited numerous pieces on the subject.
