American cities may have hit 'peak office'

The number of new office buildings in the works is extraordinarily low, and vacancy rates are at about 17%.

By Forbes Digital Nov 6, 2013 12:59PM
Office buildings reflecting clouds, low angle view © Skip Nall, Digital Vision, Getty ImagesBy Joel Kotkin, Forbes Contributor

Despite some hype and a few regional exceptions, the construction of office towers and suburban office parks has not made a significant resurgence in the current recovery.

After a century in which office space expanded nationally with every uptick in the economy, we may have reached something close to "peak office" in most markets.

The amount of new office space in development is extraordinarily low by historical standards, outside of a handful of markets.

Back in the mid-1980s, according to the commercial real estate research firm CoStar, upward of 200 million square feet of office space was built annually. After dropping precipitously in the early 1990s, construction rose again to 200 million square feet a year in the early 2000s before dropping well under 150 million square feet in 2006, and lower after that.

This year, in what is purported to be the middle of an economic recovery,  we will add barely 30 million square feet, according to Reis Inc.

Even with this paltry construction, vacancy rates nationwide have barely moved, hovering around 17%. This is nowhere near low enough to justify much more construction in the vast majority of markets, where office rents remain well below 2007 levels.

Indeed, the trend in real estate remains to convert office spaces to other uses, particularly residential. Large-scale office construction is happening in just a handful of markets; New York and Houston are the only ones with 10 million square feet being built, with smaller amounts in the works in Boston, Washington, Dallas-Ft. Worth and the San Francisco Bay Area.

Most of the current anemic growth is happening outside downtown areas. Silicon Valley, which is essentially a sprawling suburb, currently has about as much construction as San Francisco. In Houston, another big metro area with robust job growth, there is a new 47-story high-rise being developed downtown, but much of the action is taking place on the periphery, notably in the Energy Corridor. Exxon Mobil's (XOM) massive new campus, at 3 million square feet, ranks with One World Trade Center in Manhattan as the nation’s largest new office projects.

Through the third quarter this year, the amount of new office space under construction in suburban areas was roughly double the amount being built in central business districts, by CoStar’s count. Furthermore, only 7.1 million square feet of office space was absorbed downtown in the first nine months of 2013, compared to 51.5 million in suburban areas, CoStar says. But overall there is still 100 million square feet less space being used today than in 2007, and at current absorption rates, it could take six or seven years just to get back to where we were before the recession.

The weak economy
The key question here is not the geography of office space but why so little is being built. As long as economic growth is modest, don’t expect much change in the skyline in most downtowns, or suburbs. Job growth has been mediocre at best, and much of that has been in the low-wage and part-time category. McJobs and part-time workers do not generally fill office towers.

The dirty little secret of this recovery is that labor participation rates are at the lowest level since 1978. Underemployment is rife, at around 18% to 20%, and much of that likely includes large numbers of people who used to work in offices.

This is true even in New York City, where the rate of "office-using employment" has been dropping since the late 1960s and even in the recovery, has yet to rebound to the levels of 2000.

Changing use of space
Just as we have gotten used to more fuel-efficient cars, companies now utilize space more efficiently than before, largely through information technology. This is a trend many companies plan to accelerate. In the past, for example, your average mid-level executive had his own secretary; now it’s more common to have perhaps one aide for several managers. Historically office developers assumed that each worker would require 250 square feet of space; by the end of the decade this could drop to 100 to 125 square feet.

Even the most notoriously bureaucratic of professions, law, is scaling back. A recent Cushman and Wakefield survey found that most firms -- many already downsizing -- were working to reduce their office footprint per attorney from 800 to 500 square feet. Almost two out of five expect to use “hoteling,” or the sharing of offices among attorneys, something very rare a decade ago.

At the same time, some of the sectors that are the best bets for expansion, such as information technology and media, are increasingly seeking out unconventional office space. Mayor Mike Bloomberg’s drive to upzone large parts of midtown Manhattan to create ever-taller towers works operates on the assumption that new users will be much like the old ones. But some experts, such as New York architect Robert Stern, suggest that ultra high-rise development does not appeal to either creative businesses and tourists, while preserving older districts, with already developed buildings, does.

Self-employment and home-based businesses
Perhaps the biggest long-term threat lies in the shift from corporate to self-employment. From 2001 to 2012, the number of self-employed workers grew by 14%, according to a recent study by Economic Modeling Specialists. This is occurring not only in the metro areas that suffered the worst during the recession, such as Phoenix; Los Angeles and Riverside-San Bernardino, Calif.; but also in the healthiest economies such as Houston and Seattle.

Some of these now self-employed workers may end up in small offices, but many don’t leave home at all. Working at home is growing far faster than commuting by either car or transit, and in most U.S. metro areas, far exceeds those who get to work by public conveyance, most often to downtown areas. Over the past decade the number of U.S. telecommuters expanded 41% to some 1.7 million, almost double the much-ballyhooed increase of 900,000 transit riders.

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