The U.S. office market experienced steady but mild improvements throughout 2012 with year-end analysis showing the 11th consecutive quarter of national occupancy growth and eighth straight quarter of rent increases, with these gains mostly realized in tech-heavy and energy-rich geographies. The fourth quarter presidential election and avoidance of the “fiscal cliff” set the stage for a broader recovery in 2013.
National net absorption totaled 7.5 million square feet in the fourth quarter, bringing the total to 28.2 million square feet of space absorbed during all of 2012. Rents increased 3.1 percent over the course of the year, while rent abatement concessions fell by 10.8 percent, and tenant improvement allowances decreased by 4.3 percent, which indicates a continued market tightening. The national vacancy rate declined to 17 percent at the end of 2012 from 17.6 percent 12 months earlier. Of the 44 U.S. office markets JLL tracks, 84.1 percent experienced occupancy growth during 2012.
Despite the slight tightening of overall occupancy levels, the pace of the office recovery declined 19.4 percent in 2012 compared to the vibrant market experienced in 2011. California and Texas alone accounted for 60.3 percent of the country’s total net absorption.
The Growth Engine
A major source of recent leasing activity and new requirements in nearly all geographies came from the home mortgage industry. We predict that if housing momentum keeps up, you can expect homebuilders to return to growth and come back into the market for more space over the next 18 months. Consequently, geographies throughout Florida as well as growing markets such as Phoenix, Atlanta, Orange County, and Las Vegas are likely to be some of the leading office market segments over the next two years.
The conclusion of the 2012 presidential election also brought some certainty that translated into office demand. The Affordable Care Act (ObamaCare) and the Wall Street Reform and Consumer Protection Act (Dodd-Frank) seemed certain of implementation after the election, evidenced by a recent spurt of government office requirements on the market. We calculated that the federal government leased more space in Metro D.C. in the six weeks following the election than in the preceding 10 months.
New requirements for space to operate state-sponsored healthcare exchanges have emerged in Sacramento, Baltimore, Central Florida, and other markets. We expect that state and federal exchanges will likely span several million square feet across the country. To administer and enforce healthcare reform, government agencies such as the Health Resources and Services Administration and the IRS also may take extra space in Washington, D.C., and regional economies. However, despite the gains in rent and occupancy experienced in 2012, the U.S. office sector faces significant challenges to demand that threaten long-term growth prospects.
Traditional office tenants — banks, law firms, accounting and consulting firms — are adding headcount, but their real estate footprints are shrinking as they move to increasingly efficient floor plates and spaces. In fact, Jones Lang LaSalle has found through its research that banks and law firms that relocate thereby reduce their space needs by an average of 15 percent. We expect this trend will continue for the next several years as many more companies continue to right size.
The Year Ahead
One of the top emerging commercial real estate trends to watch in 2014 is “collaborative office consumption,” which involves the short-term sub-leasing of space, by large corporate occupiers or owners, to temporary users on very small scales and with very short lease durations. The area of lease can vary from as little as one desk or one conference room, to as large as an entire floor plate. The duration of lease can be as short as one hour or as long as one month.
This emerging trend has incredible benefits and opportunities for large corporations and small, growing companies. JLL Research has documented that an average corporate office maintains a steady-state vacancy of up to 30 to 40 percent, due to permanent employees who are traveling, on leave, or working remotely. With the appropriate workplace design and security, collaborative office consumption can unlock valuable capital and allow companies to monetize their temporarily vacant real estate. For small companies, start-ups, and consulting firms, collaborative office consumption provides their employees with temporary space exactly when they need it and where they need it. To date, there are more than 5,500 spaces available for collaborative office consumption on various websites throughout the nation. This number appears to be growing by the thousands each month.
Overall, in order for a full recovery to take root in the U.S., companies need to return to the market and invest in technology, equipment, real estate, or human capital at a faster clip than we saw in 2012 and at rates similar to those experienced in other recoveries. Until this happens, this trend contributes to the stabilization, but not necessarily tightening, of the office sector recovery in the short-run, but it may also affect the larger economic picture over the longer term. While the United States is in a better economic position than most other developed countries, especially among the private sector, market players are searching for the confidence domestically and globally to reinvest the capital they have been sitting on to fuel future growth.