Overview
The economy continues to underwhelm as we complete the first quarter of 2013. Job growth so far this year in the United States is trending upward, but not at a pace that matches 2012. Although the “fiscal cliff” was averted at the beginning of the year, critical decisions have been postponed until later in 2013. One of the results of the failure to come to a budget agreement is “sequestration,” mandatory across the board budget cuts, which took effect March 1 and is contributing to ongoing economic uncertainty in the private sector.
U.S. employers added just 88,000 jobs in March, less than half of what was expected, following 268,000 jobs added in February. The good news is unemployment has steadily declined since peaking at 10.0% in October of 2009. And while unemployment ticked down to 7.6% in the first quarter, job growth only kept pace because of people leaving the job market. The share of Americans seeking jobs is at its lowest since 1979. In Canada, the picture is even more gloomy. The unemployment rate is 7.2%, up slightly from end of year 2012, with 26,000 jobs lost since the beginning of 2013.
With economic growth continuing slowly, the office and industrial markets continue to improve. First quarter 2013 absorption for both office and industrial property remains at the quarterly pace of last year and availability continues downward. Demand for Class A office space and modern distribution space is strong.
Business Drivers
The United States economy, while growing, is off its 2012 pace while the Canadian economy shed jobs in the first quarter of 2013. Despite the stock market reaching a new record high and a recovering housing market, sequestration and government austerity measures are resulting in slower economic growth. Both retail sales and job growth were weaker than forecast in the first quarter.
The Standard & Poor’s/Case Shiller index of housing prices as of January 2013 reports an annual increase of 8.1% for the 20-city composite. Housing construction continues to increase as well following the great recession and housing crash. The housing recovery has bolstered construction jobs and could result in added demand for office space related to mortgage processing and for industrial space related to production and warehousing of construction materials.
Month-to-month employment growth in the United States averaged 183,000 new jobs added in 2012. New jobs in January, February and March of 2013 were 119,000, 236,000 and just 88,000, respectively. The possibility of weaker job growth in 2013 may dampen demand for office and industrial space as the year progresses.
Some parts of the economy are performing better than others. In March alone in the United States, government austerity measures resulted in 7,000 government jobs lost. Manufacturing lost 3,000 jobs and retail lost 24,000. Construction gained 18,000 jobs in March despite lingering cold weather. Office using jobs continued to increase, with Information, Financial Activities and Business and Professional Services making gains.
For the 12-month period between January 2012 and January 2013, 2 million jobs were added to the U.S. economy. Of those, approximately one-quarter were Business and Professional Services. In addition, the Trade, Transportation and Utilities and Education and Health Services sectors each added more than 400,000 jobs, and it is notable that the Health Care and Social Assistance category accounted for almost all of these. Health Care jobs will have a positive impact on demand for medical office space and general office overall, particularly build-to-suits. Manufacturing and Construction added jobs as well, and Government was the only sector to contract year-over-year.
Canadian employment has been negative thus far in 2013 after posting mostly positive growth in 2012. The unemployment rate in Canada has inched upward to 7.2%. Factors affecting these employment losses include reduced exports (the United States is Canada’s primary trading partner), weakened consumer confidence and spending, and government austerity measures.
Employment growth over the past 12 months has been concentrated in the largest metro areas, with Los Angeles, Houston, New York City and Dallas topping the list with more than 100,000 jobs added. San Francisco rounded out the top five, followed by Atlanta, Chicago, Boston, Seattle and Phoenix.
Coastal and Texas cities generally account for the greatest job growth, but other cities, such as Minneapolis, Denver, and Nashville, each added at least 30,000 jobs in the year ending February 2013.
North America Office and Industrial Fundamentals
The performance of 2011 and 2012 appears to be continuing in 2013, as available industrial and office space in most metro areas continues to shrink as absorption outpaces deliveries.
In the U.S. office market, absorption was 14.6 million square feet during the first quarter of 2013. This continues a trend that began in the third quarter of 2011 and is a significant increase over the 9.5 million square feet in first quarter 2012. Availability has now fallen to 11.8%, the first time it has been below 12% since prior to the great recession. Notable is Class A absorption, which represented just over half of all first quarter absorption despite being less than one-third of inventory. Yet Class A availability remains higher at 13.1% than overall availability. This means that demand for Class A space appears strong, but there remains substantial availability in many markets. It is too early to tell whether 2013 absorption will beat the 75 million square feet in 2012, but overall trends point to reduced availability as the year progresses.
The Canadian office market is mostly stagnant to start 2013. Overall, the major office markets had negative absorption of 570,000 square feet for the quarter, with only Vancouver reporting positive absorption. Compounded by significant completions of 600,000 square feet coming on line, his has pushed vacancy up over 9%.
Rents have fallen to $21.36 per square foot on average across the United States. Class A rents have also fallen slightly from year-end 2012 and now average $27.29 nationwide. Rents in Canada are largely unchanged despite rising vacancy. Overall, new supply and new buildings under construction are adding choices for tenants in many markets.
U.S. Office Market – Q4 2009-Q1 2013
Absorption in the U.S. industrial market continued the trend from 2012, with absorption of 47.2 million square feet, slightly less than the 53.3 million for 4th Quarter 2012 but still greater than any other quarter since the great recession. Availability now stands at 8.6%, and could drop below 8% by year end.
More than 132 million square feet of new industrial space is forecast to be delivered by year end, and while that may not keep pace with absorption; this is good news for companies in the market for new, modern warehouse space. Nonetheless, reduced availability may drive companies to consider build-to-suit deals to satisfy specific requirements.
The Canadian industrial market is also performing well. Availability is less than 5% in both Toronto and Vancouver. First quarter absorption in Toronto was nearly 3.1 million square feet.
U.S Industrial Market – Q4 2009-Q1 2013
Market Highlights
The South Bay/San Jose market topped the list for the greatest amount of office absorption in the first quarter of 2013. Coupled with the East Bay/Oakland and San Francisco proper, the Bay Area overall had absorption of 2.5 million square feet. Northern New Jersey and New York City ranked second and third and together had 2.1 million square feet of absorption. Chicago and Dallas/Fort Worth round out the top five, followed by Tampa, Orange County, Denver and Raleigh/Durham.
Absorption in Canadian markets was weak in the first quarter of 2013. Vancouver led with just 125,000 square feet, while both Toronto and Calgary experienced negative absorption for the quarter.
Of the “big five” industrial markets (Atlanta, Chicago, Dallas/Fort Worth, Inland Empire/Los Angeles, and Northern New Jersey), Chicago, Inland Empire and Atlanta topped the list for first quarter industrial absorption. Boston and Toronto rounded out the top five, followed by Memphis, Detroit, Kansas City, Baltimore, and Phoenix.
Of the 40 largest industrial leases signed in the first quarter of 2013, nearly half were in the “big five” industrial markets. As well, a significant number were in other seaports like Savannah and Jacksonville, and inland ports such as Memphis and Indianapolis.
Outlook
The economy continues to grow, although at a rather tepid pace. Each month’s economic reports are a mixed bag, and indecision out of Washington isn’t helping the economy gain momentum. Despite this, real estate trends continue to remain positive, and both the industrial and office sectors began 2013 in the black.
Industrial availability seems more and more likely to dip below 8% by year-end, and office availability could similarly fall to 11% or less. Although absorption was substantial at the beginning of 2013, continued demand for space throughout the year is by no means certain.
Opportunities for Tenants
While office availability remains at a level above what is considered to be at market equilibrium, recent absorption of Class A space could result in constricted supply in some markets. As availability for industrial space continues to decline, tenants may look to build-to-suit opportunities, and they may see rising rents for the most modern space. Regardless, companies’ demand for space in both office and industrial sectors will remain fickle, and the likely outlook in the near term will be redevelopment of aging and functionally obsolete buildings rather than the construction of new space.