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Thinking About Office Development? Consider These Submarkets

April 14, 2014
By: Paul Leonard, Real Estate Economist with CoStar Group

If you’re thinking about building office space in this cycle, you’d better dust off those blueprints and get back into the game soon, before it’s too late.

The office cycle is about halfway through the recovery phase: Demand continues to rise and is expected to peak by 2015-16. Supply remains mostly concentrated in a handful of markets, rent growth finally cracked the 3% level last year, and NOI growth should return in 2014.

All this means that projects kicking up dirt this year will deliver -- and more importantly, stabilize -- just in time, before fundamentals unwind.


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Exhibit 1 below shows what we consider the best submarkets to target for office development. The criteria (see footnotes below) we used in our analysis attempts to limit the choices to office submarkets that have a minimum existing stock of 4- and 5-Star buildings, little new supply currently underway, but enough forecast supply to accommodate new building, solid rent growth prospects, manageable occupancy rates throughout the forecast, and finally, strong enough pricing on newer office buildings to justify construction. Based on this criteria, we narrowed our list of over 1,400 submarkets down to 18.

It’s a good start, but this eclectic list offers varying opportunities.

Major markets such as Boston and Chicago fared well, but LA dominated the list with five submarkets that met our criteria. The LA metro as a whole has been a late-recovery market with little new office development to date, but West LA has fared better, thanks to larger concentrations of tech and entertainment tenants. Also, NIMBYism in the form of height restrictions and general community opposition to large projects means that if you can start a project, competition will be limited.

If you’re betting on job growth in the entertainment industry, Century City and Burbank are good targets. Pricing on top buildings is north of $600 per square foot in these submarkets, which is more than 10 times the current asking rent for top space, suggesting pricing is at levels that exceed replacement cost (see Exhibit 2).

Denver’s Southeast Corridor, which includes both the Denver Tech Center and Meridian submarkets, also makes a compelling case for new office development. The Denver Tech Center is the more mature of the two and offers better connections to the rest of the metro.

While it is largely built out, assembling outdated flex/R&D, low-quality office space or retail space for new development for redevelopment would not be that difficult. Only one 4- or 5-Star property has delivered here over the past decade, and a new property could command a significant rent premium over the competition.

Other secondary markets, including Seattle and Orange County, also make the list, but are less than ideal. For example, Seattle’s CBD will soon have a couple of large projects underway, limiting opportunities, and Orange County’s Irvine Spectrum makes a great case for development, but ownership is dominated by the Irvine Company.































Footnotes



(1) Criteria: More than 150,000 SF of new 4 & 5 Star supply added since 2004; forecast supply growth exceeding 500,000 SF; total SF underway less than 50% of forecast supply growth; forecast rent growth exceeding 3% annualized; 2018 forecast occupancy of 85% or higher; forecast occupancy movement of five percentage points or less; ratio of six or higher of the weighted-average price/SF of 4 & 5 Star assets from 2011-13 to the current 4 & 5 Star asking rent.







































Keep up weekly on national news, trends and property leads with the Watch List Newsletter, a weekly pdf that includes other news and leads not found on the CoStar Group web news pages. Sign up for the Watch List E-Mail Alert. A new issue is published Monday mornings.

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