Jones Lang LaSalle Reports Demand for Office Space Is Increasing

Constrained construction and heated demand for office space in the most-active segments of the U.S. office market are already fueling prospects of rental increases and new office property development in 2013 and into 2014. An expansion period is approaching for the high-quality urbanized office sector of trophy skyscrapers known as the Skyline, according to Jones Lang LaSalle’s Spring 2013 United States Skyline Review.

“In all but a handful of the Skyline markets, large tenants will have few existing options to consider and thus will be forced to look at proposed development options if they desire to explore relocation options,” says John Sikaitis, senior vice president of Research at Jones Lang LaSalle.

Jones Lang LaSalle’s proprietary Skyline report identifies and tracks micro-segments of 34 city centers across the nation, including the Trophy and Class A buildings where tenants and investors alike have focused demand for office space in a flight to quality and efficiency throughout the recent recovery.

“These are the segments of the markets that always lead the rest of the office sector in trends of leasing, rent and ultimately investment growth,” Sikaitis adds. “The reason behind that is that these core micro-markets are increasingly where demographics are shifting and thus where tenants most want to be, allowing supply fundamentals to be tightest, giving investors the ability to capture tenants, grow rents, shrink yield and even construct new buildings.”

Vacancy rates are in the single digits in 10 Skyline markets, including Pittsburgh, Richmond, Bellevue, Houston, Portland, the New Jersey Hudson Waterfront, Raleigh, San Francisco, Philadelphia and Boston. Additions to supply are only beginning to appear, with office construction in eight, or 24.2 percent, of the Skyline markets, including speculative construction in three markets. By mid-2014, all of the Skyline markets will have reached equilibrium, where the balance of supply and demand has historically made rents pop and new construction feasible, Jones Lang LaSalle’s researchers predict.

Three large office tenants that returned space to the market in 2012 skewed overall leasing totals across the Skyline, with a minimal net change from the previous year. Excluding those deals, however, Skyline absorption would have tipped the scales at more than 4.6 million square feet. Energy and tech companies will continue leading absorption in 2013, counterbalanced by right-sizing among law, financial and consulting firms that seek greater efficiency by cutting back space, typically between 15 percent and 20 percent.

Landlords offered fewer concessions to tenants in 2012, increasing effective rents by 4.5 percent, compared with just 1.6 percent effective rent growth the previous year. More than 85 percent of Skyline markets will see rent increase in 2013, with compression of tenant incentives in 90 percent of markets as landlords gain pricing control. In some Skyline markets, asking rents even surpassed prior market cycles’ peaks in four markets (San Francisco; the New Jersey Hudson Waterfront; Washington, D.C.; and Cincinnati).

Skyline sales volume fell to less than 40 million square feet in 2012, down 29.3 percent from 55.7 million square feet sold the previous year, chiefly due to limited Skyline Trophy activity in New York. Despite reduced volume, investor appetite for the high-quality product and favorable fundamentals is pushing sales prices nearer to pre-recessionary peaks in the top five Skyline markets (New York; San Francisco; Washington D.C.; Boston; and Seattle-Bellevue), and even in top energy markets like Houston and Denver.

Real-estate investment trusts topped the list of buyers in 2012, accounting for 29.6 percent of sales transactions, closely followed by institutional domestic buyers at 29.1 percent, with global buyers coming in a distant third at 11.9 percent. An increasingly diversified economic and leasing recovery are expected to push activity levels up more than 20 percent in 2013 for the “Super Seven” primary markets (Boston; Chicago; Los Angeles; New York; San Francisco; Seattle-Bellevue; and Washington, D.C.). Stronger investment activity will be based on increasingly difficult barriers to entry.

“Look for markets like Denver, Indianapolis, Minneapolis, Orlando and Portland, among others, to capture enhanced institutional demand over the next few years based on aligned supply and demand and an increased institutional focus,” says Marisha Clinton, director of Capital Markets Research, Jones Lang LaSalle.

Major market highlights:

  • New York: Near-term, large blocks of space weigh on the market, including 3 million square feet that a financial services firm returned to downtown Manhattan in 2012.
  • San Francisco: Sizzling leasing velocity drove up asking rents by 27.4 percent in 2012 from the previous year. New projects are breaking ground in the South Financial District.
  • Washington, D.C.: Tenants’ flight to quality bolstered the Skyline, bucking the malaise of the market. Concession packages hovered near record levels in 2012, however.
  • Boston: Rapid technology growth and recovering legal and financial services contributed to full recovery of jobs lost during the recession. Widespread absorption and built-to-suit construction in the Back Bay is accompanied by pre-recession rent levels in premier properties.
  • Seattle-Bellevue: The highest price paid per square foot for an office building here in 2012 reached $642, an all-time high.

Request a copy of the Skyline report.

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