By Michael G. McGuinness
The U.S. office markets averaged just 4.4 million square feet of positive net absorption over the past two quarters; specifically, 4 million square feet were absorbed in the fourth quarter of 2017 and just 1.3 million square feet were leased on a net basis in the first quarter of 2018, according to CBRE. These figures came in significantly below the 10.8 million-square-foot-per-quarter average forecast six months ago.
Dr. Hany Guirguis, Manhattan College, and Dr. Joshua Harris, New York University, believe that this performance represents a significant conundrum as every economic indicator used to forecast absorption performed at or above the forecast level. Some of those indicators included the Institute of Supply Management’s Non-Manufacturing Purchasing Managers’ Index and related measures such as the Conference Board Measure of CEO Confidence. Further, closely related macroeconomic variables — such as office-using employment — grew steadily, meaning that more office employees were added without much corresponding space leased over the previous six months. While the first quarter reading of just 1.3 million square feet absorbed may be a one-time anomaly, it cannot be ruled out that a structural shift in the office space market has occurred or is occurring.
Allowing for the probability of a shift in office leasing, given the current level of economic activity, the forecast for net absorption of office space has been reduced to 8.4 million square feet for the remaining three quarters of 2018 and 10 million square feet per quarter in 2019. The most plausible explanation for this shift is efficiency gains in office space utilization; however, there will be a rational limit on how far these gains can go. At some point, demand for office space (in terms of square footage) should increase, assuming economic growth and employment gains continue, especially if there is growth in the office-using sectors. Further, it is plausible that lack of specificity regarding elements of the new federal tax law, as well as late first quarter threats about “trade wars,” may have caused some companies to temporarily delay expansion plans. If that was the case, then the rest of 2018 may show outpaced gains in net absorption.
Cushman & Wakefield’s newest occupier report, “Space Matters,” dives deep into four areas of importance to today’s CRE executive. It analyzes the national trends behind office density, amenities, parking and concessions. Additionally, it provides market-by-market comparisons of vital benchmarks for 40 of the country’s largest and fastest-growing cities. Over the past 10 years, occupiers have been allocating less square footage per employee. The national average is 194 square feet per employee, which is down 8.3 percent from 2009. Square footage per worker varies across markets; in some markets it is less than 135 square feet per employee (such as Seattle and Washington, D.C.) while in others it is in the mid or high 200s (such as San Mateo County, California, and northern New Jersey). More expensive markets tend to have less space per employee, but the rate of densification is more dependent on the amount of new office supply created since the recession.
Occupiers have been allocating less square footage per employee, but that trend is starting to slow down as businesses grapple with the right balance of personal, private, communal and break space. Cushman & Wakefield expects that more densification will occur, but at a slower rate as companies supplement most private space reductions with increases in shared space. This re-focusing away from the “me space” to the “we space” is more mainstream now. With considerably more storage now taking place in the cloud (not actual filing cabinets) and the workforce having more flexible schedules, desks and workstations are becoming smaller and more right-sized. At the same time, many landlords are ramping up amenities to their tenants, which translates to more common space areas for dining, working out, conferencing and relaxing, which often leads to higher rents per square foot. Co-working centers have accelerated the wave of these changing office layouts. This new product type has also impacted how corporate occupiers think about the layout, quality and flexibility of their office space.
This balancing act will result in less attention on purely reducing square footage per employee and more emphasis on the effectiveness and flexibility of the office space.
Overall, an analysis of the economy, including the variables known to explain office demand, suggests that office markets should be getting healthier, yet the national vacancy rate has moved up by 40 basis points over the past six months, according to CBRE. Thus, office developers should exercise caution in moving forward on speculative projects in many markets. Given that current completion rates are still below long-term averages and that asking rents are still rising, it is logical to believe that the space markets will improve in future quarters. Further, many developers, lenders and even tenants are not over-expanding or being overactive, meaning that there is a low likelihood that there will be excess space that they will need to vacate in a downturn. Hence, the cautious behavior now should result in less pain for the office markets in the next downturn, which may occur in late 2019 or 2020.
(Portions of this article were obtained from the Second Quarter 2018 NAIOP Research Foundation “Office Space Demand Forecast” and blog post from May 31, 2018, by David Smith, vice president for research for Cushman & Wakefield)
Michael McGuinness is CEO of NAIOP New Jersey and has guided the commercial real estate development association’s progress since he joined the staff in 1997. In addition to overseeing daily operations, programs and staff, McGuinness directs the chapter’s legislative activities and manages the Developers Political Action Committee (DPAC).
