IRVINE, CA—A slow, steady recovery, such as the office sector is facing, isn't so bad as long as nothing occurs to disturb it. However, Ten-X Commercial sees rising cyclical risks for the sector, stemming from a deceleration in office-using job growth as the national economy reaches full employment and tenants have less need to expand their space requirements.
Broadly speaking, that slowdown is behind Ten-X's analysis of the five markets where investors may wish to consider selling their office properties—and, conversely, the five markets that show the greatest promise. Oakland, CA; Portland, OR; Sacramento; Dallas and Atlanta all are boosted by a combination of population growth and strong employment, keeping rent gains healthy even when more supply is factored in. For Oakland in particular, employment levels are at an all-time peak, boosted an increase in the metro area's professional business services sector.
At the other end of the spectrum are Memphis, Baltimore, Houston, Fort Worth and Suburban Maryland. In the case of Fort Worth, rent growth has been considerably slower than in Dallas, and all five of these “sell” markets new supply is meeting with slow or even negative absorption rates. The nation's top “sell” market, Memphis has seen employment growth of less than 1.5% over the past year.
“While we're seeing tepid growth nationally, office investors have to be aware of cyclical risks associated with subdued job growth,” says Peter Muoio, chief economist with Ten-X. “It is noteworthy that our analysis resulted in downgrades in 17 regions, and an upgrade to only one. That said, a number of economically vibrant metro areas around America are seeing high levels of absorption and present buyers with strong investment opportunities.”
On a national level, vacancies remained flat at the beginning of 2017 and have subsequently hit the midyear point with no improvement, according to Ten-X. Vacancies remain at a level far higher than during the prior expansion.
Accordingly, stalled vacancies have meant lower rent growth, with rents advancing at their slowest pace since 2012. Ten-X says it expects vacancies nationally to reach a cyclical trough of 15.3% in 2018, although the firm's downside recessionary model foresees vacancy levels reaching 17.6% by the end of 2020, on par with their recessionary peak in 2010.
And while office rent growth has slowed in recent quarters, Ten-X expects growth to reach the mid-2% range on an annual basis next year. The company's downside recessionary model projects office rents to contract by less than 1% by 2019 and by less than 1.7% the year after that, as vacancies reach recessionary levels.
Ten-X's Office Market Outlook also takes note of changes in both technology and workplace culture that have combined to reduce the market demand for office space. The firm cites the growth of cloud computing behind a diminishing need to devote on-location space to servers and computers, while the increasing obsolescence of paper filing further lowers space requirements. At the same time, Ten-X says, the growing embrace of open-floor plans has been lowering the square-foot-per-worker ratio.
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Paul Bubny
Paul Bubny is managing editor of Real Estate Forum and GlobeSt.com. He has been reporting on business since 1988 and on commercial real estate since 2007. He is based at ALM Real Estate Media Group's offices in New York City.
