Like employment, demand for office space improves - barely

The office vacancy rate fell only slightly during the first quarter, as a lack of significant job growth continued to impede demand for space, according to a quarterly report released on Tuesday.

At the same time, U.S. office construction during the first quarter reached a 14-year low as developers remain spooked by soft demand and meager rent growth, according to real estate research firm Reis Inc.

Persistent lackluster U.S. job growth was behind the 0.1 percentage point U.S. office vacancy rate decline. Demand for office space hinges on hiring workers to fill it. Although hiring in February reached 236,000, that level has not yet been consistent enough to convince employers to commit to leasing more space. In areas where the growing technology and energy industries are dominant employers, rents are increasing much faster than the national average.

The first-quarter vacancy rate stood at 17 percent compared with 17.1 percent in the fourth quarter, according to preliminary figures from Reis. The vacancy rate was down a scant 0.30 percentage point from the prior first quarter.

"It's really in line with our expected trends, given that hiring hasn't accelerated," said Victor Calanog, Reis' vice president of research. "It's so indicative of weak demand in the office sector that quarterly construction figures are at a historic low and yet vacancies are not really cratering."

Much of the vacancy decline can be attributed to a lack of new supply and not a strengthening of demand for space.

In the first quarter, only 1.578 million square feet of new office space came online in the United States, fewer square feet than some Manhattan office buildings. It was the lowest quarterly amount of new completions since Reis began publishing quarterly data in 1999.

Businesses occupied only 4 million more square feet in the first quarter, an increase equal to the prior quarter but more than 20 percent lower than the 5.3 million square feet the prior year.

On an annual rate, the additional 4 million square feet absorbed in the first quarter would translate into one-third to one-fourth the rate traditionally leased up during a comparable time in a recovery period, Calanog said.

Although the first-quarter's vacancy rate is well below the cyclical peak of 17.6 percent seen in the second half of 2010, it remains far above the 12.5 percent cyclical low in the third quarter of 2007 before the onset of the recession.

Given high vacancy rates and lenders that are still skittish about committing relatively large amounts for construction and development financing, it is hard to justify breaking ground on new office projects, Reis said.

Meanwhile, the national effective rental rate - which measures rents after subtracting months of free rent and other costs that landlords incur to attract tenants - grew at the glacial pace of 0.7 percent to $23.15 per square foot during the first quarter.

Before those costs, asking rent also grew by only 0.7 percentage to $28.66 per square foot.

That was a slowdown from the 0.8 percent pace in the fourth quarter but still greater than the quarterly average of about 0.4 percent increase seen since rents began rising consistently in the fourth quarter of 2010. Reis tracks 79 U.S. office markets.

The U.S. effective rent is still about 7.7 percent below the peak level in the second quarter of 2008, right before the collapse of Lehman Brothers sparked a financial meltdown.

Still, the U.S. property market is really a collective of vastly different local markets. Property markets that have strong energy or technology sectors have fared vastly better than the nation as a whole.

San Francisco, New York, Houston, and San Jose, California, all saw effective rent growth rise more than a full percentage point. Effective rent in San Francisco rose 1.7 percent to $35.60 per square foot annually, while New York's rose 1.6 percent to $49.63 per square foot. Houston was No. 3, with rent up 1.5 percent to $21.22 per square foot, and San Jose was up 1.1 percent at $24.65 per square foot.

Phoenix, Las Vegas, Detroit and Dayton, Ohio, had vacancy rates of at least 26 percent, Reis said.

At 9.5 percent, Washington D.C. had the lowest vacancy rate in the first quarter. Reis does not expect that to continue.

"We're looking at rising vacancies at least over the next couple of years," Calanog said, adding that the surrounding office markets also will feel the brunt of U.S. budgetary cuts.

(Editing by Matthew Lewis)