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Office overbuilding: Will it be a problem over the next two years?

Sep 12, 2017

buildings-landscape-320x213.jpgThe U.S. economy experienced soaring equity markets, growing consumer and business confidence and steady job creation over the last six months. While that’s certainly nothing to complain about, experts are increasingly wondering if recent economic success combined with shifting dynamics in the labor market puts office markets at risk of overbuilding.

Cushman & Wakefield published office forecasts for more than 100 global cities to judge the risk of overbuilding. From saturated top markets to booming secondary markets, developers, and investors alike face risk and opportunity over the next two years.

Top markets could watch vacancies rise

U.S. office markets are in position to add more than 100 million square feet of new completions by the end of 2018. That’s 30% below the peak before the Great Recession and 60% lower than during the Dot-com Boom. While that may suggest there is no immediate fear of overbuilding, Cushman & Wakefield’s data shows the majority of new completions are concentrated in just a few markets, including Manhattan, Washington, DC, San Francisco and Dallas.

Although top U.S. cities have been among the strongest absorbers throughout the cycle, it’s likely some of these markets will watch supply outstrip demand as new space delivers. While not dramatic, that imbalance will push up vacancies over the next two years in core U.S. markets. This trend could also accelerate the pace of leasing concessions, which are already common in parts of New York City and Washington, DC, as the economy nears full employment and job growth slows.

At the same time tech markets are slowing. Most peaked earlier in the cycle and are now combating housing affordability challenges and labor shortages, and while tech hubs like Silicon Valley, Seattle, and Austin are still creating jobs, the growth rate is steadily decelerating. These factors put office markets in tech hubs in danger of saturating as the cycle extends.

Booming secondary markets

While 50% of new office buildings are delivering in just 10 major markets, secondary markets are experiencing more measured levels of construction. Beyond that, many secondary markets and areas in the Sunbelt are under building relative to job creation, largely because these cities are growing jobs at a faster rate than most top markets. These dynamics are set to push office vacancy rates down 4.7% in Orlando, 4% in Phoenix and 2.5% in Portland by 2019. Those figures contrast sharply with major markets, like Dallas, where vacancy rates are expected to climb 2.9% over the same period.

There are growing opportunities for development in secondary markets as large markets move toward saturation. While developers have yet to target every secondary market in the country, they certainly have honed in on Nashville. The city currently has the lowest vacancy rate in the U.S., yet new completions are set to almost quadruple over the next three years compared to the last three as developers take advantage of the under built market. A similar theme is unfolding in Charlotte, Raleigh and Denver, and over the next few years vacancy rates in these markets will climb as developers add product to capitalize on growing regional labor markets.

Stability in U.S. markets with pockets of opportunity

Despite cases of overbuilding and advancing vacancy rates in top U.S. markets, Cushman & Wakefield predicts office markets will remain stable through 2019. The economy has been improving and that success is expected to continue; Q2 GDP was revised up to 3% and real GDP is forecast to accelerate from 2.1% this year to 2.3% in 2018.

The U.S. is near full employment, and while that means job growth rates will slow and force vacancy rates up in markets with too much supply, even this dynamic is not ultimately unfavorable to office markets. The commercial real estate industry benefits when the economy is strong, and that’s the case now given that we are near full employment and real GDP is advancing. But as job growth slows it’s likely the boom times are over in top U.S. markets. Cushman & Wakefield’s data shows that asking office rents are projected to grow at slower rates over the next few years, and most markets are only likely to see rent growth between 1% and 3% through 2019.

While that’s a slowdown, the combination of solid market fundamentals and overall economic strength lends office markets stability. But the excitement isn’t completely over. Although top markets are approaching saturation, many secondary markets are underserved and booming, giving developers the opportunity to capitalize on shifting trends in the labor market.

Topics: Industry News

Erik Dolan-Del Vecchio

Written by Erik Dolan-Del Vecchio

Erik writes about the people, the deals and the trends that move the commercial real estate industry.

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