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According to the latest report published by Jones Lang LaSalle Incorporated (JLL">JLL), a leading real estate investment trust (REIT), the U.S. office sector witnessed a spurt in market fundamentals in fourth quarter 2011 with a significant positive absorption and increase in occupancy and rents, although the performance remained relatively dispersed by both geographical location and market types.
Absorption refers to total square feet leased over a specific time period in a specific geographic area, while positive absorption is a measure of the net square feet leased after taking into consideration the space vacated during the period.
In its report titled “Fourth Quarter 2011 United States Office Outlook” that tracks 43 U.S. markets to provide ‘an overview of supply and demand, pricing conditions, a statistical analysis and an outlook on future performance, Jones Lang further predicted that despite a tepid economic recovery in the domestic market and continued uncertainty in the global macroeconomic environment, the U.S. office sector is likely to continue its growth momentum in 2012 at a somewhat similar pace exhibited in 2011.
Key Performance Highlights
The U.S. office sector reported about 10.3 million square feet of positive absorption in fourth quarter 2011 (the seventh such quarterly increase on the trot), bringing the tally for the full year to 34.6 million square feet, compared to 13.4 million square feet in 2010 or approximately thrice reported in the previous year.
Total U.S. vacancy levels in the office sector during fourth quarter 2011 plummeted to 17.6% – the lowest recorded since the second quarter of 2009, and significantly below 18.5% reported in the year-earlier quarter. At year-end 2011, vacancy rate in the Central Business Districts (CBD) was14.2%, while that of the suburban markets was 19.6%.
The office sector is highly correlated to job growth. The U.S. economy ended 2011 on a high note in terms of job growth, with 200,000 jobs added in December – about 50% better than the monthly average of 2010, bringing the official unemployment rate to a three-year low of 8.5%. For full year 2011, approximately 1.64 million jobs were added in the U.S. economy, with office job creation growing at an annualized rate of 1.2%. However, during fourth quarter 2011, office jobs had outpaced the annual growth rate at 1.8%, adding about 475,000 new jobs.
Aberration by Market Types
As evident by a disparity in vacancy rates in CBD and suburban markets, rent increases also varied considerably across both market types throughout 2011. While CBD rents increased 4.8% on a year over year basis, suburban market rents improved by a meager 1.1% or by less than one-fourth of CBD.
The dismal performance in the suburban markets pegged back the overall rent growth for the U.S. office sector at 2.8% for full year 2011, which was largely driven by strong growth in coastal urban markets and areas dominated by the technology and energy firms.
During fourth quarter 2011, overall U.S. office sector rents surged 0.9%, with CBD rents rising 2.7% and suburban rents decreasing 0.2% on a year-over-year basis. Out of the 43 markets in which Jones Lang carried out its survey, the CBD markets that fared well and were recovering at a fast pace were Austin, Texas, Midtown South in Manhattan and San Francisco. The suburban markets on a high-growth curve included Northern California markets of East Bay, the San Francisco Peninsula and Cambridge, Massachusetts.
Aberration by Geographical Location
The performance of the U.S. office sector in 2011 also varied widely by geographical locations, with New York and Washington DC – the two largest office markets in the U.S. accounting for about 20% of the total office space in the country, lagging behind, and California and Texas leading the way. While California accounted for 25.7% of the total occupancy gains in the U.S. in 2011, Texas registered a healthy 15.9%, thus accounting for 41.6% of total positive absorption in the country during the year.
In addition, California witnessed a 20% rent growth and a 2.5% decline in vacancy rate with 1.8 million square feet of net absorption during 2011, driven largely by the proliferation of high-tech industry growth in the region.
Contrarily, the performance of New York and Washington DC faltered due to low investor confidence resulting from the uncertainty in the political environment. 2012 being a presidential election year in the U.S., there is a high probability that the U.S. policymakers would refrain from making any radical change on key issues. With political indecision likely to persist in the country until at least the elections are over and the lack of concrete fiscal planning, most companies are playing a tactical ‘wait and see’ game before committing on expansion opportunities.
Furthermore, a sovereign debt crisis in Europe has resulted in the euro struggling for survival, sending ripple effects across the globe. For most of the latter half of 2011, investors have been the victims of inconsistency in the political process across Europe, ending in market volatility.
Consequently, office leases during the second half of 2011 in both markets declined by approximately 25% to 35%. This in turn led to a modest rise in vacancy rates and a dip in asking rents.
On the other hand, markets that were traditionally considered weak office markets namely Tampa Bay and Orlando fared relatively well in 2011 with a considerable increase in absorption and tenant demand. Tampa Bay witnessed a huge demand for office space by healthcare services and providers, while Orlando reported a surge in office leasing due to a booming tourism sector. The office sector is expected to grow at an annualized rate of over 6.0% in the region.
Although uncertainty in the domestic political environment and austerity measures among the European countries are expected to impede regional economic growth, buoyant job growth in most of the regions in the latter half of 2011 is expected to provide an encouraging sign to the companies who have paused in terms of expansion initiatives.
Consequently, we remain bullish on office REITs such as Boston Properties Inc. (BXP">BXP), Liberty Property Trust (LRY">LRY), Duke Realty Corp. (DRE">DRE) and Mack-Cali Realty Corp. (CLI - Analyst Report) and expect these companies to generate a relatively strong performance in 2012.