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Office Starts Surge on Strength, Stability of US Office Market at Midyear

Updated: Developers, Investors Continue to Advance Office Projects Despite Slowing Growth in Rent
August 3, 2017
Shorenstein Properties is building the 24-story City Center in Oakland, one of the hottest office submarkets in the country.
Shorenstein Properties is building the 24-story City Center in Oakland, one of the hottest office submarkets in the country.
U.S. office developers added 38 million square feet of new office space in the first six months of 2017, nearly 10% more than the same period last year, and construction starts are just now kicking into overdrive. More than 144 million square feet of office product was under construction across the U.S. at midyear 2017.

By the end of the year, CoStar is projecting the U.S. office stock will increase by nearly 90 million square feet, a new high for the current cycle.

The heightened office construction levels are having an impact on office vacancy and rental rates. U.S. office rent growth in the office sector slowed across a majority of U.S. markets in the first half, with year-over-year national rent growth down significantly to 1.8% at midyear compared to 4.4% a year ago, well below the 2015 peak of over 5%. CoStar forecasts that rents will tick down to 1.7% by the end of the year.

The U.S. office vacancy rate, meanwhile, which held steady at a cyclical low of 10.2% in the second quarter, will probably drift up to 10.4% by year's end but the rate is expected to hold steady despite the robust deliveries of new supply.

While new groundbreakings are beginning to slow over the last couple of quarter, CoStar construction data suggests that office construction activity is hardly petering out; large projects broke ground in several of the nation's largest metros during the second quarter.

To illustrate the market's durability and health, CoStar office analysts spotlighted several of the second quarter's largest new construction starts during the recent CoStar State of the U.S, Office Market Q2 2017 Review and Forecast. Here are the highlights.

The Jacx, Long Island City, NY

While six of the 10 largest U.S. office projects currently under construction are at the World Trade Center, Hudson Yards and other sections of Manhattan, one of the largest projects in the country to break ground during the second quarter is across the Queensboro Bridge in the rapidly growing Long Island City neighborhood.

The Jacx, two 26-story towers with a combined 1.2 million square feet of office and retail space, is under construction at 28-01 Jackson Avenue in Long Island City. Across the street, Tishman Speyer is constructing 1,800 apartments and another 13,000 square feet of retail in three separate towers.

In a tight office submarket with a vacancy of just 6.9% vacancy for the best properties, the project by Tishman Speyer was already 72% leased at the beginning of the third quarter in advance of its projected 2019 completion, with such lead tenants as Bloomingdale's and WeWork.

Until this year, the Northwest Queens submarket had seen little office construction since the end of the recession, but that has changed this year, with more than 1.4 million square feet under development.

"While there are a lot of projects under way, there's also a lot of demand," noted CoStar Portfolio Strategy Managing Director Hans Nordby. "Tishman Speyer has done a masterful job with the preleasing and is really building a neighborhood there."

CoStar Director of Research/Office Walter Page added that while most office buildings add about 20% occupancy from the start of construction through completion, "this property could come out of the gate at over 90% occupancy."

Oakland City Center, Oakland, CA

On the opposite end of the country from New York City across the San Francisco-Oakland Bay Bridge, Shorenstein Properties is building a 596,767-square-foot office project in Oakland, one of the hottest office submarkets in the country.

Construction of the 24-story tower at 601 City Center illustrates how dramatically rising rents in San Francisco have driven demand across the bay. The project at the northern end of Oakland's financial district, not scheduled for delivery until January of 2019, is already 33.6% leased in the tight downtown Oakland submarket.

"There's a huge delta between Oakland and downtown San Francisco in terms of rents," noted Page, adding that gross rents for City Center are about $64 per square foot, a huge discount to properties in downtown San Francisco where new buildings are renting for $100 to $110 per square foot.

The project, with easy access to BART and surrounded by housing and amenities, is a natural fit for lead tenant Blue Shield, which wants to maintain a Bay Area presence and draw from the San Francisco labor pool but is more price sensitive than many of the high-tech tenants clamoring for space in downtown San Francisco.

As more millennials start to form families, many will move out the Bay Area suburbs, and buildings like City Center located halfway between the outer 'burbs and San Francisco will likely perform very well, Nordby noted.

620 South Tryon, Charlotte, NC

The Charlotte office market is making bank on banking companies, as evidenced by Bank of America's leasing of a new building being constructed at 620 South Tryon Ave., the site of the now-demolished former Charlotte Observer building.

Goldman Sachs Group and Lincoln Harris broke ground on the 853,073-square-foot project, the first office tower of more than 500,000 square feet built in Charlotte since 2010, in early April, with completion scheduled in two years.

BofA, which is consolidating its space in 15,000 employees in Charlotte, has preleased 65% of the building's top floors, said CoStar Portfolio Strategy Managing Consultant Paul Leonard.

800 Capitol St., Houston

Houston has taken its lumps as a result of the economic slump caused by the ongoing plunge in energy prices, making the groundbreaking of a new 778,000-square-foot office building in the city's CBD a real attention getter.

After all, the Houston CBD is laboring under a 15.7% vacancy rate, with at least nine existing Four- and Five-Star buildings in the area offering 200,000 square feet or more in contiguous vacancy.

Bank of America has committed to a large block of space, however, developer Skanska has preleased less than 30% of the building scheduled for delivery in mid-2019. The pain from the oil bust is likely to be a burden in the market for some time to come.

"Most commodity cycles last seven to 10 years, and Houston is only three to four years into the current cycle," Nordby said.

Further, there are future plans to renovate 800 Bell St., ExxonMobil's former headquarters, which could pose further leasing competition for the Skanska project.

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