By JENNIFER S. FORSYTH
Office landlords had a heyday in 2006 as rents rose at the fastest pace in six years. Yet there are signs that conditions could be turning a little more in the favor of tenants.
Newly released data by Reis Inc., a New York real-estate research firm, show that office rents rose 9% nationally last year, the heftiest increase since the height of the technology boom in 2000. However, the report also found that demand for new office space slowed sharply near the end of last year, a sign that large rent increases may not continue.
Demand for office space is measured by tracking the "absorption" rate, a closely watched number that quantifies the change in the net amount of occupied space. In the fourth quarter, tenants in the nation's 79 largest markets absorbed a net 7.6 million square feet of space, according to Reis, compared with 11.6 million in the third quarter and 15.9 million in the second.
"It is clear that investors cannot expect the same pace of rent growth without a more cooperative level of net absorption," said Lloyd Lynford, Reis' chief executive. He noted that slowing growth in demand for office space tracks closely with the slowdown in employment growth in the second half.
Throughout most of last year, many companies took big blocks of office space, hoping to lock in rents before they moved higher. But several months ago, the mood began to change, real-estate experts say. "Now people are waiting to see what will happen in the economy," said Barry Gosin, chief executive of Newmark Knight Frank, a real-estate services firm. "It's not an ominous sign, but it's certainly not as heated as it was."
If companies continue to hold off renting more space, landlords are unlikely to be able to command the hefty rent increases they saw last year. In the fourth quarter, the increases in effective rent -- the amount tenants pay after concessions -- were as high as 5% in some markets and averaged 2.3% nationwide.
Real-estate experts say it is too early for property investors to panic, even at a time in which office buildings continue to sell at record prices and yields, or initial returns on investments, are at an all-time low.
The national absorption number somewhat masks the strong demand that continues in some markets -- often in the very ones where record sales have caused mouths to drop, said Chuck Schreiber, chief executive of KBS Realty Advisors, Newport Beach, Calif.
Moreover, Mr. Schreiber said, the biggest risk to the office market -- overbuilding -- doesn't seem to be a concern, at least in many of the hottest markets, as land and construction costs continue to limit new supply. According to Reis, 72 million square feet of office space should be opened nationally this year -- the highest level in several years but well below the 126 million that opened in 2001.
Even so, that amount of new construction is enough to put upward pressure on vacancy rates, said Reis's Mr. Lynford. The national vacancy rate finished last year at 13.3%, sustaining its tiniest drop in 10 quarters, at 0.2%.
Some of the cities that saw the strongest growth in effective rents in the fourth quarter will be hard-pressed to replicate those numbers going forward, Mr. Lynford said. Flashy results in some markets over just one quarter could indicate that landlords cut back significantly on concessions designed to lure new tenants -- such as a year of free rent.
Now, Mr. Lynford said, to sustain similar levels of effective-rent growth, they must cut back further on concessions or drastically raise their asking rental rates -- options which may be hard to justify with demand slowing.
Yet, in Houston, a city that saw 4.9% effective rent growth in the fourth quarter, brokers said demand for space -- particularly in the central business district -- is as strong as they can remember, thanks to the energy sector's continued growth. Though rents per square foot in Houston remain low by the standards of pricier markets such as Boston, San Francisco, and New York, some landlords there were able to raise their rates twice or three times in 2006, said Steve Biegel, senior vice president for Studley, a tenant representation firm.
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