Coastal Markets See New Cracks In Fundamentals, Though Supply Remains Mostly in Check With Demand Nationally
High-end office markets from Manhattan to Santa Monica are feeling the sting of job losses and a rise in available sublet space, and the consensus among owners and landlords is that rough times may last through at least the middle of next year.
New York City, by far the nation’s largest and most expensive office market, posted negative net absorption for the second straight quarter -- with an especially sharp decline in the bellwether Midtown Manhattan market -- while asking rents are beginning to flatten and investment sales took a sharp dive in the first half. The Westside of Los Angeles also saw vacancies rise more than half a percentage point and absorption dipped into negative territory.
That said, an analysis of CoStar Group Inc. midyear sales and leasing data shows that more than two-thirds of the nation’s office markets reported positive absorption in the most recent quarter. Construction and new supply remains in historical balance with inventory, full-service rents continue to go up and gross leasing activity rose for the second straight quarter, though the latter remains 7% below year-ago levels.
(Editor's Note: CoStar Group's Midyear local and national office, industrial and retail market reports are now available to all CoStar Property Professional subscribers. (Simply click on Market Reports after logging in with your password.) The reports are also available for purchase individually, or on an annual subscription basis.)
While hardly resembling a major downturn or collapse, the U.S. office market vacancy rate edged up to 11.7% in the second quarter, up 60 basis points from a year ago. More than two-thirds of the metro office markets tracked by CoStar saw vacancies increase over the past year. Nationally, 7 million square feet was absorbed in the second quarter, up from 1.88 million square feet in the first quarter, but down sharply from the 25.1 million square feet recorded during second quarter 2007.
Midtown and the Westside were sizzling this time last year, with no ceiling in sight to rent hikes and vacancies well within the single digits. With little or no new space slated to deliver landlords held most of the cards. But that’s changed at midyear 2008. Sublet space is rising and vacancies are edging up in some submarkets, while asking rents have at least flattened their meteoric rise. In some submarkets, the spread between asking and effective rents has widened, in part due to an increase in the amount of "shadow space" available for rent but not officially on the market.
"Demand has deteriorated in Manhattan and it’s going to be a very challenging environment for landlords for the rest of ’08, and probably much of 2009," said Ken McCarthy, Cushman & Wakefield’s managing director for New York research. "Leasing activity is really flat , both in New York City and nationally compared to a year ago. The economy remains soft and that’s likely to continue."
"You do have landlords in some submarkets pushing to raise rents, but it’s really mixed right now," McCarthy said. "Overall, the market has come more into balance and tenants have more options."
Whether analysts describe it as 'the bottom end of vacancy equilibrium,' a 'leveling of the playing field' or the beginning a 'tenant’s market,' occupiers clearly hold more power than they did a year ago. While it's unclear yet how much more sway tenants enjoy in dictating terms, free rent, parking and tenant-improvement allowances, relocation rebates and other landlord concessions are again figuring at the negotiating table.
Manhattan Activity Slows
New York City saw absorption go negative for the second straight quarter, a total of 275,777 square feet of negative net absorption in the first six months of 2008. In Midtown, net absorption of Class A office space fell further, a negative 505,171 square feet, while 343,449 square feet of reported sublease space went back to the market. Midtown’s Class-A vacancy rate edged up slightly to 5.3% from 5.2% in the first quarter -- far short of its five-year high of 9.5% in early 2004. In Midtown South, the vacancy rate rose to 9.6%, compared with 7.1% a year ago, after falling to a five-year low of 3.8% in first-quarter 2007.
In total, New York City boasted the nation’s lowest vacancy rate at 5.6% in the second quarter, and by a wide margin. No other major market came closer than Salt Lake City, UT at 8.3 percent.
Average full-service asking rents edged 10 cents higher to $85.88 in Midtown in the second quarter, but stood 13.3% higher than a year ago.
If conditions are getting better for the tenant, Jonathan Anaol, president of tenant rep firm Prime Manhattan Realty, hasn’t seen much of it yet.
"It’s still a landlord’s market in that there aren’t many vacancies and offers of big concessions to rent space," Anaol said. "On the other hand, the spaces on the market aren’t moving very quickly. The market is kind of stuck in second gear."
(Editor's Note: Let me know what you think. What are the current conditions in your market and how are tenants responding? E-mail me at rdrummer@CoStar.com
The picture was gloomier for Class-A investment sales, which plunged nearly 65% in the four Manhattan market clusters in the first six months. About $6.77 billion in Midtown, South Midtown, Uptown and Downtown property sold or went under contract in the first half of 2008, compared with more than $19 billion in the first half of 2007, according to preliminary midyear CoStar COMPS sales data.
Activity stirred in the second quarter, mostly due to the distress selloff of Harry Macklowe’s portfolio. The GM Building sold for a record-setting $2.8 billion to a joint venture of Boston Properties, Goldman Sachs and a Dubai-based private-equity fund, with seller financing by Deutsche Bank. The Paramount Group picked up 1301 Avenue of the Americas for $1.45 billion and Shorenstein Properties went under contract for two other Macklowe towers.
Westside Market Tightens
In West L.A., net absorption of Class-A space stood at a negative 215,770 square feet at midyear, while 115,954 square feet of sublet space went back on the market in the second quarter, the highest since the third quarter of last year. The Westside ended the second quarter with 9% total vacancy, up from 8.4% in the first quarter.
Meanwhile, the run up in rents seems to be flattening in the market west of the 405 Freeway, home of high-powered entertainment industry, legal and tech tenants. Relative strength in those industries ignited leasing activity toward the end of the quarter at projects in Playa del Rey, where Fox Interactive Media signed a lease to occupy 421,000 square feet in two buildings under construction at 12121 and 12181 Bluff Creek Drive, and Belkin International signed a lease to occupy 150,000 square feet.
The average asking price for Westside Class A space was $49.02 full service, down $1.20 from the first quarter but up significantly from $43.01 a year ago. Rising rents are prompting tenants to look east to the lower priced downtown L.A. market, where the vacancy again decreased in the second quarter.
Overall, the L.A. market’s total vacancy rate stood at 8.7% at midyear, compared with 8.2% in the first quarter -- one of the highest single-quarter hikes in several years -- and up 140 basis points from the same time a year ago.
Absorption was a negative 1.78 million square feet, a sharp reversal from the 1.14 million square feet of positive absorption during the same time a year ago. Sublease space, which typically trades at a discount of 25% or more to direct leases, ended the quarter at 4.12 million square feet, compared with 2.52 million square feet a year ago.
Orange County Continues to Sag
While West L.A. showed remarkable resiliency, Orange County vacancy spiked to 13.1% in the second quarter, up a startling 480 basis points from the same time last year.
The market, hard hit by an exodus of mortgage and financial industry tenants just as several new buildings came on line, logged 1.38 million square feet in negative absorption in the first six months, mostly in the first quarter.
Four more buildings totaling nearly 500,000 square feet hit the marketplace during the second quarter. Along with the vacant 1.77 million square feet of sublet, the new supply helped push quoted rents down another 1.5% to $30.35. The only good news is that the worst seems to be past, with most of the space from failed mortgage brokers back on the rental market.
(Editor's Note: Let me know what you think. What are the current conditions in your market and how are tenants responding? E-mail me at rdrummer@CoStar.com
I definitely see these dynamics reflected in the Chicago market. All the major metrics are off from last year, absorption, direct vacanct, transaction volume, etc. Bankers tell me not even to hope for a recovery until 3Q 2009, so I'm looking for cash opportunities and hoping pricing will continue to soften.
J.M. Melendez
Midtown Brokerage Investment Co. Inc.
Cicero, IL