Forecast Outlines Office Market Challenges

NEW YORK CITY-Office rents here and in some other markets could drop 20%, according to a new report. Some cities will weather the storm better than others, according to the winter 2009 forecast by Cushman & Wakefield, which expects that fundamentals in central business districts will continue to weaken, even as the US economy begins to improve in 2009.

The forecast says that markets where rents climbed significantly during the economic boom years are expected to post the largest declines in office rents, up to 20% in Manhattan, San Francisco and Orange County, California. Rents may hold up better in energy-producing markets like Houston, although “not necessarily for long if oil and gas prices continue to fall,” the Cushman & Wakefield forecast says. Such markets “are expected to eke out modest rent gains throughout this economic downturn.” It expects that rental rates will hit bottom by the end of 2010.

The report points out that all signs point to the recession lasting into the first half of 2009 as consumer demand contracts and businesses becomeincreasingly cautious. But it adds that most economists agree that the US will be well on its way toward recovery by the end of 2009.

In the meantime, the impact of the recession will be more severe in most CBDs than the 2001 recession when the dot-com bubble burst.” Cumulativejob losses through 2009 will be broader and deeper and turnaround likely to be slower,” Cushman & Wakefield says. One result: “The full ripple effecton tenant demand will be felt through at least 2010.”

The forecast anticipates that leasing will remain sluggish and lag new supply over the next two years, with an upturn only after an economicrecovery is firmly under way. The effect on vacancy rates will be an increase of 2% to 3% per year through 2010, pushing the vacancy levels past those of the 2002-2003 industry downturn.

Another factor that will continue to affect the markets will be sublease space, which will continue to increase. The amount of sublease space “has been rising since the beginning of 2008 and has increased fairly rapidly, particularlyin those markets that have taken enormous hits fromthe housing and financial crisis,” the report points out. In addition to the nearly nine million square feet of sublease space that went on the market in 2008, tenants in the finance, insurance and legal services sectors are expected to place an additional nine million to 10 million square feet of space on the market. “Space givebacks will be largest in Manhattan, San Francisco, Orange County CA, Fairfield County and Dallas, where these sectors account for 15% to 30% of all office-using employment,” the report states.

Despite these statistics, the Cushman & Wakefield forecast says that CBDs do not face the prospect of much new supply coming onto their markets. “New construction has been generally disciplined and kept pace with demand in most CBDs,” it states.

On the recovery side, the forecast names Boston, Philadelphia, Washington, DC and Seattle as places where markets “will be in a recovery-ready mode in 2010.”Although no major growth drivers are evident, these CBDs. diverse economies will support below average or declining vacancies, rising rents and positive absorption starting in 2010, it says. The report adds that the Washington, DC region is well positioned to take advantage of an anticipated surge instimulus spending as well as increased government regulation. The recovery is expected to be weakest and slowest in New York, as well as in its adjacent markets in New Jersey, where the crisis is most palpable due to the relatively high concentration of real estate and financial services entities.

The report, which provides summaries of the outlooks in the major US CBDs and suburban markets, forecasts that the overall vacancy rate in suburban markets is expected to rise to levels comparable to those seen during the downturnof the early 1990s, topping out in the 20% range by 2010 before slowly contracting in 2011. More than half of the suburban markets can expect more sublease space coming back to the market through 2009. Rental rates shouldremain flat-to-declining through 2010.