The national office space vacancy rate, which includes the Philadelphia office space market, stood firm at 16.8 percent in the third quarter 2014, remaining unchanged for the entire year at a level that is only 80 basis points below the cyclical high the market experienced four years earlier, according to a new National Real Estate Investor article. Since the third quarter 2013, the office space vacancies have dropped only 10 basis points with the only actual decline occurring in the fourth quarter 2013.
However, the article maintains, some qualifications are needed. Office leasing in the third quarter showed some movement with net absorption amounting to about 8 million square feet. While this level is not that high and actually falls below fourth quarter 2013 and first quarter 2014 levels, net absorption did more than double the infinitesimal total from the second quarter 2014 and exceeded the 5.8 million square feet of completions for the quarter, according to National Real Estate Investor.
With most new office construction projects requiring significant pre-leasing commitments before lenders will provide financing for development, construction and absorption remain closely linked to one another at this point in the recovery, the article reported. These challenges on the national level also have an effect on construction projects in the Philly office space market.
Despite these qualifications, the article said the improvement rate in office fundamentals “has truly been glacial.” Office vacancies were 430 basis points above the cyclical low of 12.5 percent, which was last seen in the third quarter 2007. The article added that office leasing activity has not yet strengthened to the point that it can push down office vacancies. That change will come only when payrolls swell.
While year-to-date job growth continues to improve, employers still have vacant offices in their existing space. Once unused space has been occupied by new hires, companies will start looking for new space if business continues to pick up.
In the long term, this should result in declining office vacancies, according to National Real Estate Investor. But whether the office national vacancy rate — including the rate for Philadelphia office space — will drop at a significantly faster rate is uncertain, particularly if the growth rate for the economy stays in the area of 2 percent.
In related news, the article also reported that asking and effective rents grew by 0.4 percent and 0.5 percent in the third quarter 2014. This pace was slower than that of the prior two quarters, but nonetheless maintained the slow and steady improvement that has been seen in rents, which have increased for 16 consecutive quarters. Greater acceleration in rents will likely not occur until the vacancy rate drops below 14 percent, thereby giving landlords the leverage to increase rents at a faster rate.
Despite the third quarters sluggish results, National Real Estate Investor said the economic outlook for year end 2014 is still optimistic. Economic growth was between 3.5 percent and 4.6 percent in three of the past four quarters, with the weakness seen in the first quarter 2014 appearing to be an anomaly. The rate of growth is that of an economy that “is finally showing some strength,” the article reported. Monthly job gains, which have been consistently above 200,000 and averaging about 230,000, are strong enough to start pushing down office vacancies, the article reported.
This scenario will encourage continued improvement in the market for national and Philly office space. The article predicts slow rent growth of about 2.6 percent for the fourth quarter and then increases in 2015. Vacancies should continue to migrate to lower levels in the final quarter of the year, but will remain “extremely sluggish” in 2015, the article said.
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