Office Vacancies Turn Around

So funny how news happens.

I have been working with CoStar Group, "the number one provider of information, marketing and analytic services to commercial real estate professionals in the United States," according to its pr types, on an interesting phenomenon in the office space: Shadow inventory. Unlike foreclosed homes, in office, this is when the full space is leased, but several actual offices or desks are vacant.

Commercial Real Estate
Photo by: Nathan Guy
Commercial Real Estate

Unlike during the .com bust, when companies shut down and vacated their spaces entirely, this recession has been marked by companies downsizing.

They lay off, say, 5 percent of their work force, and those offices and desks just sit empty.

Of course many companies went out of business entirely, which drove the vacancy rate higher overall, but when we're talking about big city office space, big companies retained a lot of full space.

Check out some interesting charts.

Anyway, CoStar's CEO Andrew Florance arrived this morning for the interview on this phenomenon, but like the cat that ate the canary, said, "Before we start, I think we have some news for you."

At about 1am today, after all their data had run through whatever data system it runs through, they learned that the office vacancy rate had turned for the first time since Q3 2007. Not by a lot, mind you; just 6 basis points, from 13.86 percent to 13.79 percent. Jobs are coming back.

"If you look a March, the year over year swing in job growth was just phenomenal. The prior year had 3/4's of a million jobs lost. This year, you went to a quarter million jobs gained approximately, so it is a million jobs swing. That is a good fundamental driver for commercial real estate," says Florance.

This is an important turn for commercial brokerages, like CB Richard Ellis, Grubb & Ellis, Jones Lang LaSalle, not to mention big investors in commercial real estate like Tishman Speyer, Blackstone, Maguire Partners, Boston Properties, SL Green, Macklowe Properties, to name a few. It could also be a small sign of relief to big banks like Bank of America and Wells Fargo, which have billions in commercial mortgages, which have been souring at record rates.


"It is only about one and a half million feet less vacant space," Florance admits. "But it is as important as a sailor who has been out in the sea in a storm spotting land. A shift in the vacancy rate from climbing to falling is pretty big news."

The turn is important, clearly, but it's not the end of stress in this space.

First, there's all that shadow inventory CoStar tracked, which if you add it all up equals 420 million square feet of empty desks across America. That's nearly the size of all the office space in New York City, according to Florance, and then there's the issue of still-low rents.

"The last two years’ rapid increases in the office vacancy rate have moderated substantially," agrees Sam Chandan, chief economist at Real Capital Analytics. "Still, we should not expect a sustained and consistent improvement in occupancy until office-using employment reverses deep losses. Even in that case, lease rollovers in the office sector will remain dilutive to property cash — i.e. new leases are being signed at lower rates than the leases that are expiring — for some time yet."

In other words, it ain't over 'til it's over.

Commercial mortgage debt is still in deep trouble, when you consider properties bought at the top of the market in 2007.

There will still be big losses there, but perhaps this turn in the office sector is a preliminary sign of recovery in other sectors as well.

It all comes back to jobs.

Questions? Comments?