Recession hits office sector

The office vacancy rate plunged by 0.9% to 18.4% during the spring, and rental rates fell to levels more than 7% below those seen last year, according to BD+C Economist Jim Haughey. A number of large office markets, such as New York and San Francisco, saw vacancy levels reach 20%. Overall, net space rentals fell during the spring in every major office market except Pittsburgh.

Developers responded quickly to reduced profit prospects in the office market. Office construction spending expanded through September 2008 but has since declined 16.4% through June. Office project starts declined slowly in early 2009 and then dropped sharply in the last two months, with starts for June-July more than 50% below the average for the previous 18 months. These slow starts shrink the pipeline of work under way and assure a further 6% drop in monthly jobsite spending by next spring.

The 2009-10 office recession will be relatively mild compared to the recession earlier this decade when construction spending dropped 47% over 27 months. This time the expected decline is 22% over 19 months. Recession declines are approximately proportional to the rise in the preceding expansion period. The 2004-08 expansion in office construction was shorter and smaller than the overheated expansion that preceded the previous recession.

The good news is that three market niches show promise of relatively slight declines over the next year. Government office construction, which has so far fared worse than private development, is likely to reverse course when stimulus-funded buildings get started next year. Financial offices, a relatively small niche, appears to be past the worst of its recession, and job site spending has been stable in recent months after a 20% drop last year as a result of forced mergers by the Federal Reserve Bank and the FDIC. Lastly, office renovation projects show promise because they typically decline much less in a recession than does new office construction.