Office-market recovery is still years away

by Don Jacobson, July 18, 2010

The Twin Cities office market has fallen into such a deep hole that, if historical trends hold true, it would take more than 3.5 years to recover, according to a new analysis.

The sobering study, performed by the Minneapolis-St. Paul office of commercial real estate firm Cassidy Turley, looked at how much vacant office space has been created in the past two-plus years of layoffs and corporate downsizings and applied a widely accepted formula holding that each office employee requires 200 square feet of space.

Cassidy reports the Twin Cities office market has roughly 14.3 million square feet of vacant space, or a 20.4 percent vacancy rate, as of the second quarter. Given that, and assuming the metro area's 15-year historic pattern of office space "absorption" continues at 900,000 square feet per year, it would take 3.55 years just to get back to the 15.6 percent vacancy rate that marked the top of the last commercial real estate cycle in 2007, the study concluded.

And even that's still far above the 10 percent vacancy rate that's usually considered necessary to trigger new office development. To reach that level would take eight years, the firm said.

Absorption -- the rate at which new leases outpace new vacancies -- has been firmly in the "negative" territory since 2008. Last year was historically bad in that regard, when 1.6 million square feet of office came vacant. But the free-fall has leveled off: Only 125,000 square feet of negative absorption has been recorded in the first two quarters of this year, according to Cassidy.

No more "hoteling"

That has given rise to optimism that a long-sought recovery by office users is in the offing, said Dick Keller, a senior vice president and principal with Cassidy's Minneapolis-St. Paul office.

"I think the bleeding has stopped," he said. "The long-term vacancy analysis is somewhat sobering, but it's not as dismal as it may first appear. I think the good news here is that we've bottomed out in terms of negative absorption."

Office employers, he said, now know where they stand as far as how many workers they're going to need going forward and are ready to make longer-term commitments on leases, going back to traditional five-year deals instead of making only shorter term "as needed" commitments known in the industry as hoteling.

"I think there's a kind of a pent-up demand out there because people have negotiated short-term leases to get through the rough economy. Now that they know where they are, I believe we're going to see an end to the negative absorption."

But the plunge in office vacancy rates is unprecedented in its depth. Even the 3.5-year timeline will be considered optimistic by some because it assumes job creation in the recovery from this recession will be similar to those following other downturns -- something that's certainly not a given.

The Twin Cities market has averaged around 4,500 new office-using jobs per year since 1992. But whether that pattern will continue is unclear. If there is a new jobs-producing sector out there coming to the rescue, such as the technology in the 1990s and the financial industry in the 2000s, commercial real estate analysts say they've yet to see it.

No quick recovery

Cassidy Turley manager Jim Mayland, who authored the study, said that in order to match the historic absorption rate of 900,000 square feet per year, the metro area will have to add at least those 4,500 new office-using jobs per year.

"Basically, what these numbers say is it's not going to be a quick recovery in the office market," he said. "I think a lot of people have been hoping for that, but the thing I point out is that you need the jobs. And I don't know if you're going to see that big of a job growth."

Landlords and real estate professionals are looking for the "next big thing" in employment that could compress the recovery timeline, Mayland said.

"The only thing I can find right now that seems to be growing is 'green' jobs -- jobs making buildings more energy efficient," he said. "Owners are still doing that despite the fact that it's going to cost them a little bit more up front to do so."

Keller admits to taking a "glass-half-full" approach. "Personally, I don't think it's going to take three and a half years," he said. "If we could rewind back to those other recessions, people asked then, 'What's going to pull us out of it?' They didn't figure on the tech sector."

This economy might also offer a surprise element, too, he said. "In a year or two, we might be looking back and saying, 'We never saw the jobs surge coming in a certain sector.'"

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