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Office Landlords Expect More Deals as Shared-Workspace Companies Grab Space

Looking Ahead: Apple, Amazon Site Selections May Benefit the Office Market as Tech Growth Picks Up
July 5, 2018
Apple is reportedly eyeing Research Triangle Park in North Carolina for a research and development campus. It's one of the potential deals that could create momentum for the office market in the next six months.
photo courtesy of City of Durham, NC.

U.S. office landlords and brokers are more optimistic than they were six months ago as technology giants Amazon and Apple prepare to select development sites and shared-workspace companies take up to 1 million square feet of office space every month.

The booming economy has returned the technology sector to its accustomed role as an office demand leader at the start of the second half of 2018, according to Scott Homa, director of office research for Jones Lang LaSalle. Overall office demand dipped in the first quarter to one of its lowest points of the 10-year recovery as technology companies temporarily pulled back on leasing.

"A lot of very favorable dynamics in play will provide additional uplift and maybe nudge the office market toward increased deal velocity in the second half of the year," Homa said.

Those factors include large-scale leasing by WeWork and other shared office tenants in almost every large U.S. market. In Washington, D.C., for example, four co-working tenants have signed leases in recent months that will account for almost 200,000 square feet of new demand, according to Robert Hartley, research director for Colliers International. He adds that it's "just a matter of time" before shared office providers take over an entire building in the District.

Financial and professional firms which typically account for the bulk of office leasing are still consolidating or cutting back, however, said Andrew Nelson, chief economist for Colliers International.

"There's no sign yet of any slowdown in the tech and coworking growth, witness the huge leasing this year by Facebook, WeWork and others," Nelson said. "But that won't be enough to counter the weaknesses elsewhere in the office sector."

Decisions on expanding headquarters or building other facilities could create momentum for the office market in the next six months. Amazon's final choice for its second headquarters campus, known as HQ2, will bring an estimated 50,000 jobs and 8 million square feet of office space to one of 20 finalist communities. Apple is reportedly focusing on the Research Triangle Park near Raleigh, North Carolina, as a site for an investment of up to $2 billion in a research and development facility that could employ thousands of workers.

"Whenever a respected blue-chip organization makes a decision like that, it really validates the market and creates additional credibility," Homa said. "Certainly a headquarters decision could have really, really significant downstream effects across the broader office market."

A rising cost of living, increasing rents and a shortage of labor remain a challenge for all office-using industries, even beyond technology enclaves such as the San Francisco Bay Area, according to analysts. Higher construction deliveries are likely to outstrip demand in the next year in major markets such as Chicago, New York City and Washington, prompting landlords to start offering free rent and concessions to fill space.

"We're seeing a lot of occupiers looking for those better values and more favorable deal economics," Homa said. "Concessions are one of the more under-the-radar indicators and something that we'll be watching in the second half."

Another bright spot is that the energy industry, a major demand driver earlier in the decade, may be poised for at least a mini-rebound. With oil prices staying consistently above $70 a barrel, energy towns like Houston and Oklahoma City that have struggled in recent years willl be worth watching closely in coming months, said Cushman & Wakefield principal economist Ken McCarthy.

Houston, the only major U.S. market in the past year to post negative demand for office space, is hovering near its peak vacancy rate at 17 percent but may already have weathered the worst of the oil crisis, according to CoStar data.

The amount of subleased space dumped on the market by shrinking energy firms has gradually receded since late 2016, and Houston is one of only two or three cities projected to see rent growth, albeit very slight, in the next couple of years, according to CoStar data.

As demand slackens across the country, CoStar analysts are urging investors to stay focused on the highest quality assets which command 70 percent of total demand even though they constitute just one-third of office inventory. While office demand peaked in 2015, high-quality properties are still garnering more than twice their fair share of demand.

"There’s little reason this will cool off in the next year or two, given the hot economy," said CoStar managing consultant Paul Leonard.

Office footprints are on average 15 percent denser by square footage today than in the 1980s, dropping to roughly 215 square feet per worker, because of telecommuting and other changes in the workplace. The good news for landlords is that companies are willing and able to pay more per square foot to attract the best talent, Leonard said.

"Corporate profits are near record highs, nearly 20 percent above the last cycle, making it palatable for companies to justify reinvesting in their operations and real estate," he said. "The flight to quality has lasted far longer than previous cycles. What’s different is there hasn’t been any wavering so far in demand for high-quality space, despite record rent levels in most markets.

"Decisions aren’t being made on basis of rent, but rather on the accessing and retention of talent."

Editor's note: This is the third in a series on the commercial real estate outlook for the second half of 2018. Links to other stories in the series are below.

MULTIFAMILY OUTLOOK: Multifamily Investors Are Getting Used to 'Normal'

RETAIL OUTLOOK: Mall Makeovers, Big Box Availability Benefit Retail Growth

COMMERCIAL CONSTRUCTION OUTLOOK: Commercial Construction Surges as Demand Counters Higher Labor, Materials Costs

INDUSTRIAL OUTLOOK: Retailers, Logistics Firms to Drive Industrial Property Demand in Coming Months

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