Office Update

Apr 1, 2006 12:00 PM, By Ellen Parson, Managing Editor

After peaking at nearly 300 million square feet in 2000, the office construction market proceeded to take a serious nosedive over the next three years, plummeting 52% and bottoming out at 143 million square feet in 2003, according to figures from McGraw Hill Construction (MHC). However, after rising 13% to 162 million square feet in 2004, the slow road to recovery that began a few years ago is a path construction analysts believe the market will follow in the near future. Calling for a 9% bump to 167 million square feet, the operative word in MHC's “Construction Outlook 2006” is “slow” — as starts will certainly not approach the record level reached in 2000. That's not to say this sector's not poised for growth. According to MHC, “with gains in office employment holding at historically healthy levels, corporations will find that they must expand their office space to make room for growing ranks.”

According to its “Construction Outlook 2006,” a large portion of these ranks will be found on the country's coasts. In fact, several of the high-profile projects that materialized in 2004 in New York City's Lower Manhattan will actually help boost the outlook for office space this year and beyond. One is investment bank Goldman Sachs' new 2.1-million-square-foot “green” headquarters taking shape in Battery Park City across from the former World Trade Center site. At a price tag of more than $2 billion, the new 43-story office tower, which will be LEED gold certified, is scheduled for occupancy in 2009. Another is the infamous Freedom Tower, which after several postponements was scheduled to break ground in the first quarter this year but continues to be under negotiation. This structure, scheduled for completion in 2010, will feature 2.6 million square feet of office space as well as tenant amenity spaces, observation decks, restaurants, and more.

Although not in line with the 2000 boom quite yet, the value of office contruction is expected to continue its steady climb after bottoming out in 2003.

“Employment will continue to add jobs in the office market, especially in those sectors offering financial, business, and professional services,” says Heather Jones, a construction economist with Raleigh, N.C.-based FMI, a provider of management consulting and investment banking to the global construction industry. “This will drive demand for office space. Vacancy rates will continue to drop, absorption will continue to outpace completions, and rental rates will continue to increase.”

In its “2005-2006 U.S. Market Construction Overview,” FMI noted that expenditures for office construction ended up at a moderate 5% increase in 2005 for a total of $46.2 billion. The firm anticipates this upward trend will continue, calling for a projected increase of 10% or $4.6 billion above the 2005 level. Construction costs per square foot are also slated for a bump, due to building material shortages caused by the current construction boom in China, an improving economy, and record levels of U.S. construction.

According to FMI's report, one of the key reasons for this development includes “employment growth particularly in office-using segments, which are expected to grow at a stronger pace than overall employment, increasing by 3.5% or 1 million jobs. Coastal markets — characterized by high population growth and accelerated occupancy gains are projected to drive the office recovery while markets in the Midwest are expected to grow at a slower pace due to below average job growth and weaker economies.”

Given the growing labor market and the resulting decline in vacancies, FMI also expects rental rates for office space to rise. “One possible outcome this may have is that cost-conscious tenants will move away from the high-rent central business district areas, relocating to less expensive, lower-rent office spaces in suburban areas,” states the report. But don't count out the inner cities just yet. The same study indicates that “tax incentives offered by many inner cities are having a positive effect, and many developers are continuing to renovate old buildings in downtown areas rather than developing new structures in suburban areas.”

Such improvements tend to be in the city while new construction occurs more in the suburbs, notes Jones. “However, suburban growth is stronger than urban growth,” she says. “High-rise and low-rise vary depending upon the location. Although suburban areas tend to have more low-rise office buildings, that trend will change as suburbs become larger and begin to host more high rise buildings. This trend is beginning in some markets but is a ways off for most.”