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News release

Chicago

National Office Space Occupancy Stabilized in H1 2010 and Entering First Steps of Expansion Period, according to Jones Lang LaSalle’s Second Quarter North America Office Outlook

Fundamentals tighten across the majority of geographies; recovery being led by atypical office space users


CHICAGO, July 8, 2010— It’s official. The bottom of the national office market was reached in the first quarter 2010 and initial signs of expansion is on the office space radar for the second-half of the year as asking rents stabilized and demand levels increased for the second consecutive quarter, according to Jones Lang LaSalle’s Second Quarter 2010 United States Office Outlook. Jones Lang LaSalle’s analysis provides an overview of supply and demand conditions and statistical analyses of the major markets in U.S.
 
Office outlook highlights: Tightening fundamentals across the majority of geographies
  • National vacancy levels declined for the first time since the end of 2007, closing the quarter at an estimated 18.2 percent, down 30 basis points from 18.5 percent

  • Occupancy gains were spread across markets as 58 percent of U.S. markets displayed positive absorption in the second quarter. Positive absorption returns to the U.S. market for the first time in 10 quarters

  • Asking rents remained constant for the first time in eight quarters, settling up five cents from Q1 2010 levels
     
  • Sublease vacancy levels continued to decline for the third consecutive quarter with vacant space in that segment decreasing by more than nine million square feet since October 2009

“What we’re seeing is not a full throttle expansion in the office market, but a stabilization in both demand and supply drivers,” said Ben Breslau, Managing Director of Americas Research for Jones Lang LaSalle. “This is still a distinct change in stride from where we were six to 12 months ago. We could, however, see an extended bottom to the office cycle in most markets as the economy and job market struggle to shift into a higher growth gear. ”

Office market stabilization / expansion period begins
In an encouraging start to the second-half of 2010, Jones Lang LaSalle believes the bottom of the national office market was reached in the first quarter as office occupancy expansion returns in the second quarter. National vacancy levels declined for the first time since end of 2007, closing the quarter at an estimated 18.2 percent, down 30 basis points from 18.5 percent.

“The occupancy gains in the second quarter were spread across the nation with 58 percent of U.S. markets displaying positive absorption,” said John Sikaitis, Director of Office Research, Americas for Jones Lang LaSalle. “Due to the second quarter occupancy gains, year-to-date negative absorption levels abated with less than 1 million square feet of occupancy declines through the first half of the year. That’s a tangible improvement.”

Leasing activity increased for the fourth time in five quarters with a quarterly increase of 4.6 percent in the second quarter of 2010. Meanwhile, tour velocity picked up at a greater pace. Leasing activity increased at the highest levels quarter over quarter in New York City, Silicon Valley, San Francisco and Atlanta. Tour velocity increased nearly 7.7 percent in the second quarter, indicating more tenants are out in the market actively looking for space. Tenant tour velocity increased at the greatest rates quarter over quarter in Boston, D.C., Houston, Miami and Dallas.

Rental rates stabilize as incentives drop

For the first time in eight quarters, asking rents remained constant, settling up five cents from first quarter 2010 levels. Rents declined in the majority of markets, but leading gateway markets like San Francisco, D.C., NYC and Boston, among others demonstrated increases greater than 1 percent.

While average asking rents increased by a nickel, tenant concession packages pulled back slightly. Improvement allowances offered by landlords to tenants declined by 1.9 percent in the second quarter of 2010, while rent abatement stabilized, declining slightly from 5.2 months over an average 7 to 10 year term to 5.1 months at the end of the second quarter. Landlords continue to pullback on improvement allowances and rent abatement incentives offered to tenants as confidence in the market improved. Notably Class A and Trophy markets are faring significantly better in terms of rent stabilization than Class B or secondary submarkets where declines may continue due to lack of demand.
 
Sublease space diminishes

While leasing activity has increased on the office segment with longer terms, numerous tenants also removed blocks of space they had placed on the market in past quarters in order to accommodate pending growth. In some cases the sublease term expired, thus shifting the space from sublease to direct vacant space, but a large amount of sublease space has been removed from the market by tenants, who now feel they will utilize it for growth over the near term.

This led to declining sublease vacancy levels for the third consecutive quarter with overall vacancy decreasing by more than nine million square feet since October 2009. Overall sublease space has fallen 15 million square feet over the past three quarters. Sublease levels remain 38.1 percent higher than lows established in the second quarter of 2007; however, rates of decline continue to increase quarter over quarter with the second quarter showing a six million-square-foot drop.
 
In addition to sublease space subsiding, a strong positive sign for the office sector is an initial slowdown of the corporate rightsizing trend, which dominated tenant activity at the end of 2009 and beginning of 2010. Some tenants even leveraged market conditions and took additional space to accommodate future growth at still-discounted space during the second quarter.

Industry demand coming from atypical office space users
A trend that accelerated over from the first quarter 2010 is the number of isolated pockets of strong industry sector growth. The new emergent pockets of demand include government, healthcare, energy, education and technology sectors.

“In a typical recovery, the financial services firms are the first to re-enter the market with expansion plans,” said Sikaitis. “Now, the recovery is being led by atypical office sector users including education companies / universities, the energy sector, healthcare companies and the federal government. These sectors are not likely to push a full throttle expansion for the longer term” (see chart at right).
 
National Office Outlook

While the office markets may have reached the corner, shaky employment markets still present large challenges to near-and far-term growth.

“We have seen segmented industries pop with new demand levels, but large office users are still not growing, which should maintain some slack in space fundamentals over the coming quarters and slow a recovery. Not a double dip, but more a dip and pause,” added Breslau. “We are likely to see absorption levels bounce up and down from negative to positive over the coming quarters as the recovery remains segmented by industry and geography.”

Breslau expects vacancy levels will likely continue to increase slightly from current levels, but will hit peaks in the end of 2010. Rental declines will continue across numerous markets nationally over the next several quarters, but national average rents will stabilize as leading markets drive minimal, but countable rent growth.

Regional outlook

With expansion on the horizon, several of the national U.S. office markets displayed tighter office fundamentals through mid-year 2010 compared to several quarters ago:
  • Boston: Conditions continued to stabilize during the second quarter of 2010 in Boston as the market nears bottom. Several notable tenants in both the CBD and suburbs completed significant transactions making sure to lock in tenant favorable rates for years to come.

    “Recently, there have been instances of landlords pushing back on initial tenant proposals, suggesting that the rent correction is just about complete. At this turning point in the cycle, conditions vary greatly by geography and asset class,” said Paul Leonard, Research Manager for New England. Class A product continued to outpace the recovery of Class B product with four consecutive quarters of occupancy growth. During the second half of the year, as market conditions continue to improve, more tenants will sense the urgency to transact in order to lock in favorable terms.

  • Chicago: Although marginal, the second quarter marked the return of positive absorption after six quarters of negative demand. The positive results were concentrated in the CBD, with contributing factors including new tenants entering the market and a sustained drop in sublease listings. Additionally, a significant uptick in sales transactions was recorded during the quarter, which should further boost tenant confidence and translate into increased leasing activity in coming quarters. Looking ahead, overall vacancy levels are expected to stabilize as no new supply is projected to deliver to the market in the near term.

    “With supply now stable, the focus is squarely on demand. We are anticipating that the next few quarter’s results will prove to be uneven as steady job growth is not expected to materialize in the region until 2011,” said Rena Christofidis, Research Director for the Midwest.

  • New York: The Manhattan office market exhibited further signs of stability during the second quarter of 2010. Leasing activity is up considerably over last year, while the number of large blocks of space coming back to the market has slowed. With demand finally outweighing supply, vacancy levels improved in some submarkets leading to positive absorption for the overall market.

    “Encouraging data in the labor market bodes well for New York in the long term, but overall asking rents are likely to remain stationary for the remainder of the year,” said Jim Delmonte, Research Director for the Tri-State region. The Manhattan office market enters the second half of the year with positive momentum and modest tightening. While the summer months are typically slow in terms of activity this year may be different since the market has reached bottom. Tenants with looming lease expirations are in a favorable market while those with longer-term leases may decide on early renewals. Throughout the remainder of the year, Midtown vacancy is expected to slowly drift lower while Downtown will continue to rise.

  • Los Angeles: The Los Angeles market continued experiencing negative net absorption during the second quarter, although significantly less than last year, indicating that the market might be close to reaching bottom. Much of the second quarter leasing activity was centered on renewals, with few tenants expanding.

    “Larger Los Angeles regional corporate users sought to capture favorable rents and available concessions by remaining at their current location, and avoiding costly moves,” said Henry Gjestrum, Senior Research Analyst in Los Angeles. “Other tenants took advantage of sublease opportunities with significant remaining-term and generous build-outs, particularly on the Westside.” Large upcoming lease expirations might result in additional space coming to the market through 2011, before Los Angeles leasing activity regains positive momentum driven by consistent job growth.

  • San Francisco: Technology firms and high-end space users are leading a break away from the overall market, but heavy drag from commodity space will weigh down performance in 2010. Key submarkets south of Market Street dominated by technology firms are tightening significantly and leading recovery efforts with an injection of new demand that’s rebalancing negotiating power and allowing landlords to nudge rents upward. This same situation exists for top tier view space in the Central Business District. However, these encouraging pockets of strength and healthy leasing activity are being muted by commodity space overhang, yielding mixed results. Vacancies increased by 10 basis points on negative net absorption during the quarter, yet optimism and demand conditions provided for higher asking rents.

    “Expectations may be ahead of actual performance metrics, but the innovation engine that drives demand is gearing up for recovery and being led by social media, life sciences, and software firms,” added Colin Yasukochi, Research Director for the Northwest United States.

  • Washington, DC: Growth of the federal government continued to propel the Metro D.C. market during the second quarter of 2010. A decisive uptick in demand coincided with the continued thinning of the development pipeline, which helped vacancy rates tighten. The catalyst for growth was broadly distributed among various government agencies, with IRS, SEC, Veterans Affairs and Health and Human Services among the most aggressive tenants in the market. The widespread growth of the government impacted the District of Columbia, Northern Virginia and suburban Maryland alike, a unique trend given the tendency for administrations to fund only select interests in particular locations.

    “A shift from the planning stages of stimulus and regulation initiatives to full-scale implementation yielded robust gains for the Metro D.C. market in the first half of 2010,” said Scott Homa, Research Manager for the Mid-Atlantic region. “This growth offset a large portion of the oversupply that resulted from excessive speculative construction over past few years. We anticipate the government will continue to insulate the DC region and restore a sense of balance in the market before federal spending begins to recede.”
About Jones Lang LaSalle
Jones Lang LaSalle (NYSE:JLL) is a financial and professional services firm specializing in real estate. The firm offers integrated services delivered by expert teams worldwide to clients seeking increased value by owning, occupying or investing in real estate. With 2009 global revenue of $2.5 billion, Jones Lang LaSalle serves clients in 60 countries from 750 locations worldwide, including 180 corporate offices. The firm is an industry leader in property and corporate facility management services, with a portfolio of approximately 1.6 billion square feet worldwide. LaSalle Investment Management, the company’s investment management business, is one of the world’s largest and most diverse in real estate with approximately $40 billion of assets under management. For further information, please visit our Web site, www.joneslanglasalle.com.