For the first time in nearly two years, corporate occupiers are moving away from short-term tactical real estate plays exclusively centered on delivering sizeable cost savings in favor of a strategic, long-term approach to growth, according to Jones Lang LaSalle’s First Quarter 2011 National Office Occupier Outlook. Though it is not yet widespread, an increase in office space demand was recorded in the first quarter in select market segments with particular concentrations of growth industries such as technology, energy and professional services.
“Companies in high-growth sectors are beginning to explore leasing options to accommodate increases in hiring, gain strategic access to new workers, and improve the productivity of their workspace,” said Stuart Hicks, CEO of Corporate Solutions at Jones Lang LaSalle. “While economic recovery is underway, corporate real estate executives are tasked with implementing strategies to support this growth while still aggressively managing cost and risk, all while developing workplaces that enhance productivity.”
Office occupier outlook highlights
Many leading market segments are now seeing the availability of premier quality Class A space tighten, making the flight to quality executed in 2010 more challenging. As shortages of quality space emerge, especially for large size requirements, relocation options will become limited, reducing tenant leverage.
Since the spring of 2010, the U.S. office market has posted more than 25 million square feet of occupancy gains, clear evidence that competition to lease space is on the upswing. However, considering companies shed 71 million square feet in 2008 and 2009, it will take time for leverage to shift towards landlords.
While the cost of leasing space remained tenant favorable from a national perspective, signs of rental uplift returned to some core CBD office markets. Rising costs are anticipated to accelerate in top-tier market segments. In secondary markets, the rent forecast calls for stabilization through the end of 2011.
81.0 percent of U.S. markets are tenant favorable now, but more neutral conditions will take hold next year. It is predicted that only 12 percent of U.S. markets will be tenant favorable in 2013. (Click here to view the Jones Lang LaSalle United States Office Clock.)
Occupiers’ market choices highly dependent on geography and product type
In the first quarter of 2011, the U.S. vacancy rate dipped to 18.4 percent from its peak of 18.7 percent in the third quarter of 2010 as more tenants seek expansion in key markets. Recent high-profile transactions include Amazon leasing 460,000 square feet in Bellevue, WA; Groupon leasing an additional 70,000 square feet of new space in Chicago; and LivingSocial expanding in the District of Columbia.
The lowest vacancy rates were posted for Class A CBD space in New York City’s Midtown South (7.9 percent), Raleigh-Durman (7.5 percent), and San Francisco (13.6 percent). Conversely, vacancy rates for Class B suburban space in Detroit, New Jersey, Phoenix, and West Palm Beach ranged from an astounding 24.7 to 30.0 percent.
The first quarter of 2011 recorded a positive net absorption of 5.7 million square feet in the Class A market, and occupancy losses roughly 1.0 million square feet in the Class B sector.
“Many leading market segments are now seeing the availability of premier quality Class A space tighten, making the flight to quality executed in 2010 more challenging,” said Lauren Picariello, Vice President of Occupier Research for Jones Lang LaSalle. “As shortages of quality space emerge, especially for large space requirements, relocation options will become limited, reducing tenant leverage.”
Rents stabilize in light of narrowing gap between supply and demand
The U.S. average asking rent increased 0.7 percent to $27.39 per square foot. More noteworthy, only 16.7 percent of the markets tracked reported rent reductions, a stark contrast to last year’s steep rent declines.
“Rent stabilization has permeated across the nation as increased demand generated landlord confidence and prompted the winding down of the aggressive tenant incentives seen last year,” said Picariello. “Looking ahead, occupiers will see tenant improvement allowances continue to trend downward in expansionary markets, and rent abatements become more stable but below previous peak levels.”
Average rent abatement rescinded from the peak in late 2010 to 4.9 months on average in the first quarter of 2011. Tenant improvement allowances declined 7.2 percent to an average of $27.54 per square foot.
Competition to lease space is historically lower in the first quarter of the year, and 2011 was no exception, with leasing volume down 24.7 percent over last quarter. However, tour activity was up in nearly 62.8 percent of the markets tracked, indicating companies are more active in exploring the market to evaluate space options.
Unlike previous market cycles, new construction will fail to enhance the occupier position over the short-term. A small development pipeline will result in limited new construction over the next three years. Consequently, the U.S. vacancy rate will likely decline to 17.5 percent by the end of 2011 and be closer to 16.0 percent in 2012.
Winning the war for talent
The battle to attract and retain talent has become intense in both domestic and global technology-heavy markets such as Silicon Valley, China and India due to rapidly growing internet and software companies. As the recruiting battle heats up, some companies are implementing new perks and incentives, while others are using more traditional tactics, such as higher compensation levels. Google has raised the pay for new computer science grads by $20,000 over the last few months. To compete, Microsoft recently announced a company-wide pay increase targeted at software engineers in the early and mid-stage of their career along with bigger bonuses.
While the technology industry currently faces its fiercest war for talent in more than a decade, other companies are not far behind. While the U.S. unemployment rate may be high, the unemployment rate for knowledge workers averages a low 3.7 percent. Adding fuel to the fire is the pending retirement of baby-boomers and lower population rates among younger generations which is expected to lead to an 8.0 percent decrease in workforce growth over the next 10 years.
As a result of these factors, increased M&A activity and Wall Street expectations for cost management; growth is now viewed through a new more strategic and disciplined lens.
Stronger connection to the business creates opportunities for real estate to optimize productivity
The most significant impact of the Global Financial Crisis on corporate real estate was the creation of a stronger, more synchronistic connection between CRE leaders and the C-suite. The role real estate plays within the broader business, not just from a cost perspective, but to enable enterprise-wide objectives came to the forefront. Over the reminder of 2011, occupiers will be tasked with evaluating their entire operational footprint in the midst of changing demographics, labor costs, energy costs and world politics. While there will be a continued emphasis on cost management, the larger task will be preparation for smart growth strategies that optimize the business from a productivity standpoint. The exclusive focus on cost savings has been replaced by a need to create a work environment that can win the war for talent, reinforces corporate identity and helps achieve sustainability objectives.