As a dad of three boys, I’ve been watching a lot of baseball this summer. While I love watching and cheering, some of the games seem to never end – if you’re a parent of a Little League player, you know what I’m talking about.
That’s what’s happening in the office sector of the commercial real estate market. The current market is like one of those “never ending” innings that the pitcher just can’t seem to get it over the plate. When is it going to end? Please don’t go into extra innings – I’ve had enough!
Right now the multi-tenant office market would settle for a 0-0 tie – rather than loss after loss. Landlords are waiting for some indication of demand, and are showing a willingness to cut rates, increase concessions and otherwise do whatever it takes to generate new leasing activity, which is good news for tenants who start to see their businesses return to health and can start considering moving or expanding their space.
Vacant office space continued to pile up during the first half of 2010, with direct vacancy rising to 19.9% with 22.8 % in sublease – the rate of empty office space is at a 19-year high. We saw tenants giving back space across the Twin Cities, with more than 1 million square feet returned to the market as negative absorption since mid-2009. However, the rate of bad news slowed in the first half of the year with just over 200,000 square feet of negative absorption; plus we have no new space coming to the market for the next 12 months, and that will help temper the bad news.
I spend much of my time working with landlords and tenants in the Southwest and West suburbs, working on lease renewals. While few tenants have expanded, most are looking for ways to reduce their expenses, and in all cases, landlords are willing to work with them by offering less space or more favorable terms while retaining some negotiating leverage.. 2 million-plus square feet of sublease space is an additional challenge, along with a significant amount of shadow space (leased but unoccupied space) weighing on the market.
NorthMarq publishes a biannual research report called “Compass” where all of our brokerage professionals review recent leases and specific submarkets and try to understand what we think will happen next. Collectively, we know that the only way for a serious rebound in the office market is to replace jobs lost during the economic downturn. With the amount of vacancy on the books right now, we anticipate it will take nearly four years to return to what is considered equilibrium for both tenants and landlords. During the second half of the year, expect to see positive absorption – but only about 50,000 square feet – which would put absorption on the positive side for the first time since the end of 2007. Vacancy will remain near the 20% level through the next few cycles.
New construction is at a historic standstill, so increased supply of product will not be an issue for landlords in the second half.
Some parts of the Twin Cities, notably the Northwest and Northeast, haven’t yet bottomed out. Others, such as the St. Paul CBD and the South/Airport, may be in for an extended period of lethargic activity. Larger submarkets, such as the West, Southwest and Minneapolis CBD, may not shift into recovery mode during the second half but should start to see more stability in terms of vacancy and absorption. Rental rates are another story.
Some observers anticipate that the earliest deals with larger space users will be extremely telling: how far will landlords, their patience—and resources in some cases—be stretched to the limit, be willing to go to attract and retain larger tenants? A few of these stressed landlords may decide to cut their losses and strike deals well below currently quoted market rates. Once a few larger transactions occur, the market will know better what the actual floor is on rates and concessions. When we find the bottom, we at least know for sure which direction is up.
So, while the commercial real estate world continues to look for recovery, I’d recommend that we try to enjoy the game in front of us, bask in a hot sunny day in Minnesota, and find the full cooler. As a wise man once said (Steve Hoyt at NAIOP’s July 24th program), “We just need to lower our expectations and we’ll all be happier.”