Trends in Office Vacancy Rates
Since the onset of the financial crisis, everyone involved in financing and developing office properties has been watching trends in commercial real estate markets. They recognize the risk of a downturn similar to that seen in residential real estate. If the demand for office space falls or remains weak, some office properties could slip into delinquency and foreclosure. The additional supply of buildings on the market could lower the value of office properties in the near term. For these reasons, analysts should be watching statistics on office vacancy rates closely. For those not directly involved in commercial real estate, office space statistics provide useful information about economic activity and current growth.
The most recent four quarters of data on office space vacancy show that the national vacancy rate has stopped climbing and has ticked down from 17.8 to 17.4 percent. Office vacancy is also declining or steady in the Fourth District metro areas of Cincinnati, Columbus, and Pittsburgh. The trends in vacancy rates vary widely between markets and are correlated with employment growth. (Data on metro-level office vacancy is provided by CB Richard Ellis, a major national commercial real estate brokerage. The firm reports office vacancy as the percent of all existing or nearly-complete office space that is available for lease.)
In the past, vacancy has fallen when employment was growing and risen when employment was falling. The national vacancy figure was below 10 percent at the turn of the century, but it rose following the 2001 recession (payroll employment continued falling until August 2003). While the market tightened between 2003 and 2007, the recent trough remained above 12 percent, approximately one and a half times the level at the previous trough. This elevated vacancy rate does not necessarily suggest that usage of office space never returned to the levels of 2000, only that net increases in the total stock (new construction) were not absorbed to the same extent. The trends in central business district (downtown) office vacancy and suburban office vacancy follow the same pattern, with downtown vacancy consistently lower.
In addition to the long-term relationship between economic activity and office vacancy, there is a short-term connection between office vacancy and job growth. To illustrate this, we can plot the year-over-year changes by metropolitan area. In general, areas where vacancy has fallen between the fourth quarters of 2009 and 2010 have seen greater increases in payroll employment over that same period. However, counter examples exist, such as Honolulu and Riverside.
Vacancy data are available for the three largest metro areas in Ohio. Data for Pittsburgh is only available for the last two years. Over the past decade, the vacancy trends for Cincinnati and Cleveland have been very similar. Both started with around 10 percent of available space vacant in the first quarter of 2000. Vacancy rose through 2003 and then varied in a narrow band, between 17 and 20 percent, for six years. The last three quarters of data suggest vacancy has stopped rising in the Cincinnati area, but continues to rise in the Cleveland area. The Columbus data reflect a steeper increase in vacancy in the first three years of the decade, followed by a gradual decline. As of the most recent four quarters, Columbus’s vacancy rate has dropped below that of Cincinnati and Cleveland. At 20 percent, the Columbus vacancy rate remains around 3 points higher than the national average. The Pittsburgh data reflect office vacancy that is well below the national average and that was falling a full year before the national trend turned.
How do vacancy rates across Ohio compare to those of similarly sized metro areas in other regions? Vacancy levels in Ohio cities were approximately 17-19 percent at the most recent trough (2007) and 20-22 percent at the recent peak (2010). Office vacancy in Indianapolis was at similar levels in both in 2007 and 2010. The St. Louis and Denver metro areas experienced modest increases and are currently at or below 17 percent vacancy. Several Southern and Western metro areas had vacancy rates below 13 percent in 2007 but have had increases between 7 percentage points and 13 percentage points.
- Sources: CB Richard Ellis, Haver Analytics and author’s calculations.
Holders of geographically diversified office real estate portfolios should be encouraged to see the nationwide increase in office vacancy has stopped. The possible peak vacancy for this cycle is only modestly above the last peak. However, investors need to watch these trends in depth if their holdings are concentrated in certain markets such as Las Vegas and Sacramento. In cities with vacancy above the national and historical averages, we can anticipate weaker demand for new office construction and possibly falling values of office properties in the near term.