Office Tenants In Drivers Seat

June 21, 2002
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NEW YORK — Recent numbers show that current conditions in the U.S. office market heavily favor tenants over building owners, as the national vacancy rate is the highest it’s been in five years. In fact, one analyst felt that tenants are in their best bargaining position in almost a decade.

“We expect that tenants will enjoy a negotiating advantage through much of the next year due to a weak leasing environment, coupled with continuing deliveries of buildings still in the construction pipeline,” said Robert Bach, national director of market analysis for New York-based Grubb & Ellis Co.

The situation is much the same in the local office market.

“It’s like that here, too,” said Bill Bowling, chairman of Grubb & Ellis/Paramount Properties at 300 Ottawa Ave. NW.

The local Class A office vacancy rate has nearly doubled from last year, rising to 9.5 percent for downtown buildings and 15.1 percent in suburban structures this month. A year ago, those numbers were 4.5 percent and 8.7 percent, respectively.

As for Class B space, the vacancy rate is 12.7 percent downtown and 13.1 percent in the suburbs. Last year, Grubb & Ellis/Paramount pegged those rates at 6.6 percent downtown and 11.9 percent in the suburbs.

According to T.J. Pontarellia, director of research for Grubb & Ellis/Paramount, the additional office vacancy wasn’t due to overbuilding.

“Corporations are downsizing and consolidating. Companies vacate and subleases go on the market. We’ve seen a significant increase in sublet space, which we count as vacancy,” he said.

“Anyone that was dependent on the furniture market, the automotive market, and any kind of technology, anything nearly related to a dot-com, had three- to five-year leases and they had to back out,” added Pontarellia. “Which, in turn, makes it a tasty market for tenants.”

Across the nation, Bach said net office absorption fell by 30.4 million square feet from July through September, a figure that included the damaged and destroyed properties in New York. If the terrorist attacks hadn’t happened, Bach said the net loss still would have been 17.7 million square feet – similar to the decline in occupied space for the second quarter.

The national vacancy rate rose by 1.5 percent to 13.02 percent for the third quarter, the highest it’s been since the second quarter of 1996. A year ago, the third quarter vacancy rate stood at 8.5 percent. And not only is more space available nationally, office rents have also dropped — by 10 percent to 15 percent on average.

“Although the average weighted asking rental rate for Class A space is $32.36, about the same level as in the third quarter of 2000, effective rates are lower due to an increase in concessions,” said Bach. “For Class B space, the average weighted asking rent of $25.08 is down by 3.1 percent.”

Bowling said rates are unusually lower for Class A buildings in downtown Grand Rapids than in some of those in the suburbs, up to $3 per square foot lower. It’s the first time he has seen that situation since he started in the business in 1977.

“It costs more to be in a Class A building in the suburbs than it does to be in a Class A building downtown. That’s an inversion. We’ve never seen that before. Class A space has always been most expensive downtown,” said Bowling, who defines the core downtown area as running east from the Grand River to Ionia and south from Michigan to Fulton.

“We have found a couple of new suburban office buildings are now getting higher rents, including parking, by about $3 a foot than we are getting in comparable Class A buildings downtown. I’ve just never seen that before,” he added.

Bowling felt one reason for the rent inversion is that the downtown core hasn’t seen a new office structure go up since 1985 when the Campau Square Building was erected.

“When you look at all the municipal things that have happened here — the arena, the convention center, the police department, the courthouse and now the art museum — if you add those up, what are they? $500 million worth of construction? And not one dollar of new construction in office. Think of it,” he said.

Building renovations downtown may also have contributed to the change of position in Class A rents. “I don’t think it helped them any,” he said.

Bowling added that a new tenant is looking for up to 50,000 square feet of Class A office space in the core, and, under the right conditions, that company could possibly serve as the spark for a new downtown office structure.

“We now have and we are now working with a couple of major, major developers who are looking to come to town, and they said they were shocked that no new buildings have been built in the core in the last 16 years,” said Bowling.

Neither the tenant nor developers were identified.

Other national findings were:

  • The subleasing of space continued, as 108 million square feet was subleased during the third quarter. For the same period last year, 37 million square feet was subleased.

  • Building owners whose tenant leases don’t roll for two years are in the best shape to handle the declining market conditions.

  • Although vacancies are rising at the same rate for buildings in the central business district and the suburbs, the central district rate (10.9 percent) was well below that for suburban office buildings (14.2 percent).

  • San Francisco (13.3 percent), San Jose (11.6 percent), Boston (9.7 percent), Seattle (8.3 percent), and Denver (6.8 percent) posted the largest vacancy rate increases for the past four quarters.

Bach projected that the national office vacancy rate will peak at 15 percent by the end of 2002, and that businesses would likely continue to let workers go for another year.

As for the local market, Pontarellia felt that a lot of the vacancies would get gobbled up because a lot of attractive space is on the market and is going at a discounted rate.

“Tenants are running the show now,” he said. “If tenants are really smart, they would sign 10-year leases now at these rates.”    

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