Office Vacancies Drop Ahead of Expected Supply Wave

The office market remains broadly in an “expansionary” mode, with tenants driving 14 million square feet of net absorption in the first quarter, reported JLL, Chicago.

The office vacancy rate slipped to 14.7 percent during the quarter as an expected delivery supply wave paused until later in 2019 and into 2020, JLL Director of Office Research Scott Homa said. “An above-expectations end to 2018 boosted first-quarter performance as office market dynamics firm before further supply delivers,” he said.

With more than 110 million square feet of space under construction, the market awaits the critical mass of deliveries that could firmly shift conditions into more neutral and even tenant-favorable territory in some markets, Homa said. “Other themes that have accelerated over the past six to eight quarters, namely flight to quality and divergence in performance by asset class, also firmed during the first quarter and are expected to continue over the course of 2019,” he said.

Yardi Matrix, Santa Barbara, Calif, said office absorption remains “robust,” which increased office asking rents by 1 percent nationally during the first quarter.

“The increases were led by the San Francisco area and parts of New York City, and the changes in most metros were fairly minor,” the Yardi Matrix April Office Report said. “The highest increase in asking rents came from markets where new projects are pushing up the average listed price.”

Transaction activity slowed in the first quarter with just $13.3 billion of deals closed, Yardi said. That represented a 37 percent drop from first quarter 2018 and the lowest quarterly total since early 2013. Closed deals also fell below 500 for the first time in six years.

“Reasons for the slowdown in sales are not entirely clear,” Yardi said. “To some degree the first quarter is typically less active than the fourth quarter, when firms rush to close deals by year-end. But seasonality can’t be the entire cause. One possibility is that the slowdown is a carryover from the capital markets volatility in the fourth quarter, when interest rates spiked and investors were unduly worried about the state of economic growth.”

The government shutdown early in 2019 also worried some investors, Yardi said. “But there’s no reason to think demand has fallen off a cliff,” the report said. “Investors are exhibiting more caution as they assume the economic cycle hits the late stages and some foreign buyers have reduced their levels of interest as acquisition yields remain extremely tight in primary markets. Yet demand is strong for properties with the right profile in the right place at the right price and we expect office transactions to rebound in the near term.”

Second quarter office transactions could approach the $20.4 billion rolling four-quarter average, Yardi said.