Healthy Demand Taps The Brakes, As New Space Hits The Market

After a string of healthy quarterly absorption gains over the last four years, office demand softened somewhat in the first half just as the latest building boom delivered 2.5 million sq. ft. of premium office space. Nearly 1 million sq. ft. of space is under construction.

 Net absorption in Q2 countywide was negative 327,480 sq. ft. and is in the red by 705,807 sq. ft. for the first two quarters. There are 1,325 buildings countywide in the survey, totaling 114.6 million sq. ft. 

 Since early 2017, 11 buildings have been completed – including seven in South County – adding 2,548,554 sq. ft. to the inventory.  Meanwhile, over the same six-quarter period, net absorption totaled 85,441 sq. ft., which includes an increase in sublet space of 655,275 sq. ft.  The countywide vacancy rate jumped from 9.7% to 11.58%.

 Class A space, which accounts for about 42% of total inventory, posted negative net absorption of 317,366 sq. ft in the second quarter.  It was the third and largest quarterly absorption loss for premium space since Q1 2014.   

 After gains in 10 of the previous 11 quarters, Class B space absorption was negative by 709,435 sq. ft. in 2018’s first three months and down 725,134 sq. ft. through Q2.

 The Class B vacancy rate settled at 9.8%, up 110 basis points since the end of last year. Vacancies have stabilized in mid-single digits in some submarkets.  But low vacancies also will increase rents and drive tenants into top-tier buildings.  Already in record territory, asking lease rates for Class B space jumped 9.5% year over year, the biggest increase since the recession. Conversely, rents for Class A space are up 3.4% year over year, a sharp decline from the 10.5% in mid 2016.

Additionally, tenants moving from Class B buildings to new or remodeled Class A space with open floor plans and added common areas are able to put more employees in up to 30% less space. This and other factors of concern to local building owners have some anxious landlords in the Airport market offering bonuses to procuring brokers for the first time since 2015. 

 Central County posted 227,162 sq. ft. of negative 2Q absorption and the South County and North County markets were slightly negative. The only second-quarter growth was the Airport market’s 12,637 sq. ft., but that followed its 882,424 sq. ft. of negative absorption in the first quarter.

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