November 18, 2016
Each office market has a distinct supply-demand balance point, represented by its "natural vacancy rate,"1 which helps determine whether leasing market conditions favor landlords or tenants. Dynamics can vary significantly by submarket within a given metro area, with the strongest submarkets registering outsized rent growth and low concessions even in a market that overall appears to favor tenants. In addition, a market that appears landlord- or tenant-favorable based on the current vacancy rate may be moving or have moved in the other direction due to reduced demand and/or an increase or anticipated increase in supply. Even given these caveats, undertaking this exercise can be a useful gauge of general supply-demand conditions in a given market and in comparison with other office markets across the country.
So what does the current supply-demand balance look like compared with long-run trends across U.S. markets? We compared the current vacancy rate with what is considered the natural vacancy rate for each metro area tracked by CBRE Research to understand where there currently appear to be supply-demand imbalances.
Majority of markets likely in tenants' favor
In 54% of the markets analyzed, the Q3 2016 vacancy rate exceeded the natural vacancy rate, implying that the balance of power is likely with tenants. This was down from 65% of markets in Q3 2015, and the weighted average difference based on net rentable area between the current and natural vacancy rates decreased as well—from 108 basis points (bps) in Q3 2015 to 57 bps in Q3 2016.
"Likely landlord-favorable" markets concentrated in West and South"
Markets in which the natural vacancy rate exceeds the Q3 2016 vacancy rate by relatively wide margins include the San Francisco Bay Area markets of Oakland/East Bay, San Francisco and San Jose, as well as other active tech-driven markets such as Seattle, Portland and Austin. Nashville and Dallas/Ft. Worth also fall into this category due to robust demand from a diverse industry base. In Charlotte, the growth of fin-tech is boosting office leasing and diversifying the tenant base of this large, established financial center.
"Likely tenant-favorable" markets concentrated in Midwest, Mid-Atlantic and Southwest metros"
Q3 2016 vacancy rates exceeded their respective natural vacancy rates by relatively large amounts in Las Vegas, Washington, D.C., Richmond, Albuquerque and Baltimore. Yet vacancy rates decreased year-over-year in nearly three-quarters of markets in which the Q3 2016 vacancy rate exceeded the natural vacancy rate, indicating that most of these markets moved closer to equilibrium during the past year.
"Many hard-hit markets returning to equilibrium"
The markets in which supply and demand likely are roughly in balance (Q3 2016 and natural vacancy rates within 150 bps) are varied in terms of size, location and industry drivers. Many of these markets were slow to recover coming out of the recession but are registering significant declines in vacancy, including Orlando, Tampa, Sacramento, Ft. Lauderdale, Detroit, Los Angeles, New Jersey and St. Louis.
Although some metros appear heavily landlord- or tenant-favorable overall, conditions can vary significantly depending on location and building quality. For example, although Las Vegas is classified as tenant-favorable, the market for Class A space in the Southern Beltway corridor is much tighter than for older, in-fill product in other parts of the metro area. Also, Tampa, which overall skews slightly in favor of tenants, has multiple submarkets with single-digit vacancy rates as well as a single-digit Class A vacancy rate for the overall metro, reflecting severe space shortages in certain segments of the market. Conversely, office markets such as San Francisco and San Diego have tightened across the board to the point where vacancy rates in all submarkets are below their respective overall market natural vacancy rates.
"Construction generally focused on "likely landlord-favorable" markets"
Developers have responded to tight conditions in markets including San Jose, Nashville, Seattle, San Francisco, Austin, Dallas/Ft. Worth and Downtown Portland, which are active construction markets. Yet in other likely landlord-favorable markets, such as Oakland/East Bay and Atlanta, little supply relief is on the horizon due to low levels of construction currently underway relative to the size of those markets. In some markets, rents have yet to rise to a level that supports new construction, particularly given rising construction costs in recent years. Several markets that are likely tenant-favorable in aggregate, such as Washington, D.C., Chicago and Phoenix, have active development pipelines due to shortages of high-quality space and/or space in the most desirable submarkets.
1The natural vacancy rate is an estimate of the vacancy rate when supply and demand are in balance. Natural vacancy rates used in this analysis were derived from long-run office market performance as well as local market knowledge.