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2012 Office Real Estate Market Outlook: In for a Slow Recovery

Global economic uncertainty, resulting in a lack of business confidence, is overshadowing recovery in the office real estate market.

Bill Krouch , CEO of Jones Lang LaSalle Americas - Markets, Jones Lang LaSalle (2012 Directory)
The U.S. office market, like the broader economy, is recovering slower than expected. The first half of 2011 showed signs of a true recovery; however, the latter half of the year has delivered considerably slower results in terms of leasing velocity - yet we are still seeing signs of growth, albeit at a much slower pace.

U.S. office markets nationwide absorbed approximately 9.4 million square feet of space in the third quarter of 2011, bringing the year-to-date total to more than 24.5 million square feet, eclipsing 2010 levels by more than 75 percent.

While vacancy levels continue to decline, the lack of job creation could spell a future slowdown in occupancy growth, as average job gains have decreased to less than 40,000 jobs created per month since April 2011. This - coupled with the economic uncertainty in the United States, a gridlocked Congress, and the unrest in the Euro zone - means that the commercial real estate office market will most likely remain flat through 2012.

Stable Rents
Overall, average rents across the United States remained stable over the course of the third quarter, inching up approximately 30 cents to $27.74 per square foot. The pricing growth realized during the quarter was largely driven by more substantial rent increases in only a few markets rather than movement across all markets.

The San Francisco Peninsula, San Francisco, San Antonio, Miami, New York, Philadelphia, and Austin markets displayed the largest quarter-over-quarter rental increases. The San Francisco Peninsula and San Francisco markets commanded premiums greater than 3 percent compared to the second-quarter 2011 due to a continued increase in technology demand.

In contrast, the industrial Midwest markets of Detroit, Cleveland, and Cincinnati, along with the Sunbelt markets of Phoenix, Jacksonville, and Tampa Bay, displayed the largest declines over the quarter. Each market demonstrated rents moving downward at rates greater than 1 percent for the quarter.

The increased uncertainty in the global economy, combined with smaller amounts of near-term lease rolls due to "blend and extend" leases undertaken in 2010, have pushed leasing activity down substantially from prior periods. While we continue to see positive absorption overall, only select markets are seeing real rental rate increases.

We expect this trend to continue in 2012 and anticipate a very slow, bumpy recovery throughout the year. However, it is important to note that we are still seeing deals get done. While our projections have diminished slightly from the beginning of the year, we still expect 2011 and 2012 to end positively.

Markets Driving Demand

The western half of the country - specifically Texas, Denver, and the West Coast tech-heavy markets - continues to dominate gains in the market based on the strong regional economies driven by energy and technology. While overall leasing activity nationally was down 26 percent in the third quarter 2011 versus the third quarter 2010, the energy and technology market segments accounted for approximately 42.5 percent of occupancy gains despite both comprising just 20.7 percent of supply.

The Texas markets - including Austin, Dallas, Houston, and San Antonio - accounted for 17.3 percent of occupancy gains year to date, or 4.1 million square feet. Denver, which is driven by both technology and energy, has absorbed 1.2 million square feet throughout 2011, with 414,054 square feet in the third quarter. The West Coast tech markets of San Francisco, San Francisco Peninsula, Silicon Valley, and Seattle generated the most occupancy gains to date, with 4.8 million square feet or 20.1 percent.

Consumer demand for gadgets, apps, and new forms of media - coupled with businesses' technological needs - is driving high-tech employment. Employment in the high-tech and energy sectors is a bright spot in an otherwise gray economic picture. While not strong enough to uplift the entire national economy, high-tech and energy strength are positively impacting office markets across the country, with San Francisco, Silicon Valley, and Houston (energy) experiencing the strongest growth.

The Next Chapter
While office employment levels remain positive and higher than overall employment growth rates, business and CEO confidence measures have declined, meaning near-term hiring (notwithstanding the tech and energy industries) is likely to be limited, and office demand is likely to be lower in 2012. We expect that this lack of confidence, along with the uncertainty in politics and the lack of a defined fiscal policy, will continue to overshadow the commercial real estate recovery in 2012 and possibly into 2013.

These factors collectively impact the commercial real estate market because macro-issues have a profound impact on capital spending initiatives, including acquisition, occupancy, and disposition strategies. Until some direction on the above-mentioned issues becomes clear, owners and occupiers of commercial real estate will continue to sit on the sidelines and take a "wait-and-see" approach.

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