The national office market has rebounded, with no segment showing the comeback more clearly than trophy properties. It’s no surprise that class-A office space attracts the most demand, but what’s notable is how fast the landlords of those buildings have gotten back in the driver’s seat.
A lack of development since the start of the recession, along with exploding demand in both traditional primary markets and those led by energy and technology booms, have pushed demand for class-A space through the roof. Average rents for trophy properties hit $40.73 per sq. ft. in 2013, reaching past the $40 per sq. ft. mark for the first time ever, according to the recent “United States Skyline Review” report by commercial real estate services firm JLL. Last year was a good year for trophy offices, JLL researchers wrote, with almost 10 million sq. ft. of absorption, compared with 22.4 million sq. ft. of absorption recorded between 2010 and 2012.
Most trophy properties are reporting record rent increases, and of the 43 top cities studied by JLL, only one—Newark, N.J.—is expected to have a leasing environment favorable to tenants by 2016. John Sikaitis, managing director of research at JLL, says that as U.S. businesses continue to strengthen, large blocks of office space will crunch smaller properties. In New York City, for example, half of the trophy properties report a 5 percent vacancy rate. Even sublease availability is shrinking. Publicis Groupe, for example, divulged last month that it will pay close to $50 per sq. ft. just to take over a lease for 114,000 sq. ft. at One Penn Plaza in New York City from Direct Brands Inc.
Cranes on horizon
Demand has created a need for more supply, and Sikaitis says there will be announcements of new office towers in the next couple of years. There’s already about 17 million sq. ft. of office space now in the national construction pipeline, primarily in the major markets of New York City, Houston and San Francisco. The latter city has about 3.7 million sq. ft. of new office towers planned to open in the next two years. Trulia Inc., for example, recently announced it will lease almost 80,000 sq. ft. at Boston Properties’ new 27-story building at 535 Mission St. in San Francisco.
“I think you’re going to see a wave of new development announcements in the next 12 to 18 months,” Sikaitis says. “I don’t think it will be all at once, the developers will put more thought into what’s coming out at once. It won’t be the same as 2005-06, when you would have five or six developers breaking ground on towers at the same time in a city.”
He says major office tenants will also be more careful about where to locate, with buildings positioned near entertainment and transportation hubs now considered the top employee draws. “It’s not going to be like the past 10-20 years, where if you built a shiny new building it would fill up regardless of its characteristics,” Sikaitis says.
Many developers trying to attract large-scale tenants have shifted design styles to the open office configuration, featuring more open and collaborative work spaces, more natural lighting, larger floor plates and fewer individual offices. According to a recent report by Chicago-based MB Real Estate (MBRE), the millennial generation favors companies that adopt this model. The U.S. Bureau of Labor Statistics said in 2012 that millennials are expected to make up nearly half of the country’s workforce by 2020, outnumbering any other generation. The decision to embrace open office plans is made easier, of course, because it allows more efficiency and wireless work areas.
However, MBRE researchers say there are drawbacks to the open office concept, with reports of added noise and distractions, higher rates of stress and even illnesses causing underperformance by employees. “The key for commercial real estate professionals thereby remains to find an office space reflective of an organization’s culture, goals and overall structure,” according to the study.
This article was republished with permission from National Real Estate Investor.