Office Sector Stability? Be Careful

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An article in today's Wall Street Journal titled, "Office Market Starting to Stabilize" had all my bosses rearing to report the investor plays on this newly energized sector.

Hoooooold on.

Yes, this is the week that REIS, Inc., a well-respected commercial real estate information firm, reports all the quarterly numbers on all the commercial real estate sectors. It began with the office sector and the glowing proclamation, "The pace of deterioration has clearly slowed." My, that's a rave.

Office buildings still lost 1.9 million square feet of occupied space in Q3, pushing vacancies to 17.5 percent, which is a 17-year high. But the good news is that vacancies had been climbing at a much faster pace in 2009, and that's easing now.

Asking rents declined a miniscule 0.1 percent while effective rents were unchanged in Q3. "These figures represent a dramatic improvement relative to the quarterly declines recorded in 2009." Effective rates are now 12 percent below their 2008 high.

"It's too soon to get excited about office fundamentals."" -Real Capital Analytics, Sam Chandan

So less bad is good, right?

The real good news is that in certain big cities, like New York and Washington, DC, the numbers are even better. And Mort Zuckerman is betting on Boston, with his REIT, Boston Properties, buying the John Hancock Tower for $930 million.

Still, you have to be realistic in today's market because,"We don't yet have measurable growth in office-using employment," according to Sam Chandan of Real Capital Analytics. "It's too soon to get excited about office fundamentals."

The author of the REIS survey agrees, "I would temper my expectations about whether the turnaround is going to be massively strong. Since job growth really hasn't been following all that much, what's basically happening right now is that the sector entered with a fairly favorable supply situation. In other words, unlike other downturns, the office sector really wasn't overbuilt this time around," notes Victor Canalog.

While rents were essentially flat for the quarter, REIS does report a slight turnaround in September where rents actually went positive. We haven't' seen positive rent growth since late 2008, just before the economy really jumped off a cliff.

Experts say the play now is on REITs (real estate investment trusts) with really high quality product. Given the really low effective and asking rents, many tenants are taking the opportunity to move up, which means demand for high quality office space is actually competitive. REITS like Vornado, SL Green, and Canadian player Brookfield Asset Management, could be well-positioned for the recovery ahead.

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