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Once Left for Dead, Suburban Office Making a Comeback

Still Playing Catch Up, Suburban Office Markets Garner Larger Share of Demand Growth Than CBD as Office Recovery Becomes More Broad-Based
November 12, 2013
About three-quarters of all U.S. office space is located outside the city center in low-rise and medium-rise properties in suburban business centers across the country. During the Great Recession and its aftermath, suburban office markets took an outsized hit.

Some analysts wrote the obituary of the suburban office campus as downsizing companies shed millions of square feet, in many cases consolidating into buildings closer to public transit in urban centers. Suburban vacancy rates spiked above 20% and 30% in many markets.

As the economy has slowly warmed up, the office market recovery has reached into suburban markets, especially ones in so-called "premier" locations where technology and energy related companies are driving demand growth.

Overall, the suburbs have garnered more than their usual share of leasing demand over the past two years, according to an analysis by CoStar real estate economists. Since the beginning of 2012, suburban markets have accounted for a whopping 87% of office demand -- which is 13% more than their 'fair share' based on the total market size compared with CBD office markets, according to data presented at CoStar’s recent third-quarter office review and forecast.

Top-shelf submarkets are driving the suburban office recovery, including Waltham/Watertown in Boston, Northwest Austin, Bellevue near Seattle, and Katy Freeway West in Houston, to name a few, are leading the office recovery. Such markets make up just 19% of the office inventory but drew 29% of the demand over the last six quarters, according to CoStar data.

With all the talk about the shift in office demand to CBDs and tenants moving from suburban to downtown markets, "that's not necessarily happening in spades," noted Walter Page, director of office research for CoStar.

Suburban office absorption tends to perform well during economic booms and recovery periods, while CBD properties tend to perform better during downturns as companies take advantage of lower rental rates to secure space closer to the urban core.

With the recovery in the overall U.S. office market gaining momentum and rental rates increasing in the choicest CBD trophy buildings, more office users are taking a second look at the suburbs, and it's beginning to show up in net absorption.

A diverse set of markets that include Sacramento, San Jose, Austin, Kansas City and Charlotte have posted some of the strongest net office absorption among suburban markets, paving the way for occupancy and rent growth.

Even the long-suffering suburban submarkets of Chicago are seeing rising occupancy and the beginnings of rental increases in their highest quality buildings.

"Tenants are starting to realize if they want Class A space in the northwest suburban market, they have to act soon to advantage of the aggressive economics that have been offered over the past several years," said Jack Reardon of NAI Hiffman in a report on the Chicago area’s suburban office markets.

"There are few options for tenants looking for over 100,000 square feet. Over the next 12 months, demand will continue to increase, pushing rents in the highest quality buildings higher, accelerating the recovery in lower-quality buildings."

Although the vacancy rate hovers over 20% in the East-West Corridor -- the largest of the Chicago suburban markets -- vacancy in the highest quality buildings with the best amenities was only 14%, according to BAI Hiffman’s Dan O'Neill.

Landlords all over the country are noting a similar trend.

"Similar to the [second quarter], we’ve had increasing momentum in suburban office leasing," said Denny Oklak, chairman and CEO of Duke Realty (NYSE: DRE). "The suburban office sector has continued to show more positive trends."

Although national vacancies are in the mid to high teens, net absorption stayed positive for the 14th consecutive quarter and rental rates per square foot are up a few percentage points since the end of last year after nearly five years of stagnant rent, Oklak told investors.

Amid improving fundamentals, Duke Realty signed nearly 1.4 million square feet of leases in its suburban office portfolio in the last quarter, including a 58,000-square-foot lease with Farmers Insurance in South Florida.

Duke saw continuing strong suburban leasing activity in the Midwest, most notably in St. Louis with an 87,000-square-foot lease renewal with Aetna and a 75,000 square foot renewal with a major accounting firm in Indianapolis.

Even developers are becoming active again in certain submarkets such as Raleigh, NC, where Duke this week announced it will build another speculative suburban office project in its Raleigh Perimeter Park development.

Nearly two-thirds of Perimeter Three, a 245,352-square-foot, six-story building, is pre-leased to Teleflex, a medical device company. Perimeter Two in Raleigh, started earlier this year, is now 91% pre-leased and scheduled for delivery in the second quarter of 2014, according to Duke Chief Operating Officer Jim Conner.

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