U.S. Office Vacancy Rate Drops to 9.9%

The U.S. office vacancy rate, buoyed by a strong economy that has companies adding workers at a record pace, has fallen into the single digits for the first time since 1981, according to a study released Thursday.

The drop represents a dramatic turnaround for a property market that just a few years ago most analysts predicted would suffer from a glut of oversupply well into the 21st century.

“Everybody underestimated how fast [new development] would shut down and no one would have guessed that we would have seven years of uninterrupted economic expansion,” said Rodney Dimock, president of New York-based Cornerstone Properties Inc., a big owner of downtown offices.

Already, some analysts are suggesting the data provide warning signs of an imminent slowdown in the growth of high-flying real estate investment trusts, or REITs, which bought an estimated $28 billion of offices last year.

“This potentially could slow their earnings growth because they no longer have a chance to increase occupancy rates much,” said Lawrence Raiman, a real estate analyst at Donaldson, Lufkin & Jenrette Inc. “It’s going to be more challenging for REITs to do exceptionally well.”

Raiman lowered his rating on the REIT industry to “market performance” from “outperformance.”

Office REIT stocks are down 3.4% so far this year after rising 30% in 1997, according to the Bloomberg Office REIT Index.

The U.S. metropolitan office vacancy rate stood at an average 9.9% at the end of December, down from 12.1% at the end of 1996 and a high of more than 19% in 1992, according to the report from Los Angeles-based property broker CB Commercial Real Estate Services Inc.

Some cities, such as San Francisco, Boston, Minneapolis and Seattle, have vacancy rates of less than 6%. In New York, the world’s largest office market, the rate is 7.7%.

“The demand for space seems to be continuing unabated,” said Raymond Ritchey of Boston Properties Inc., one of the country’s biggest office developers and owners.

San Francisco; Houston; Manhattan; Hartford, Conn.; and Fort Worth posted some of the biggest jumps in occupancy.

With space scarce, landlords are using their leverage over tenants to impose hefty rent increases.

Boston Properties, which owns properties from Boston to Washington, D.C., has seen rents in its markets increase 10% to 15% a year in the last two years. Billionaire financier Sam Zell’s Equity Office Properties Trust, the largest office owner in the U.S., is seeing rents in many of its markets increasing 15% to 20%.

Landlords see no slowdown any time soon.

“We are confident that we are in a three- to five-year window of opportunity,” Ritchey said.

To take advantage of this window, investors last year bought about $46 billion of office properties, according to real estate investment banking firm Granite Partners Inc. Public companies accounted for 60% of the total.

The buying was led by Equity Office, which purchased about $6.5 billion of real estate since going public in July. Boston Properties, Richard Rainwater’s Crescent Real Estate Equities Inc., Vornado Realty Trust and CarrAmerica Realty Corp. each spent at least $1 billion.

This buying spree helped push property values up about 20% last year, Granite said.

In what some call a warning sign, for the first time since the 1980s investors are paying premium prices and accepting a low initial return in the hopes that they will be able to boost rents down the road.

Last month, Los Angeles-based Arden Realty Inc. agreed to buy 50 office and industrial properties in Southern California for about $615 million. Analysts estimate the transaction translates into an 8% annual return, below the 9% recent average.

Tower Realty Trust Inc. last month bought a Times Square building in Manhattan for $141 million, $26 million more than the sellers paid to acquire the property just two months before.

For 1998, CB Commercial’s research arm estimates 58 million square feet of space will be added to the supply.

Amid concern over rising development, PaineWebber Group Inc. issued a report last week that “raised a yellow flag” on office REITs and lowered the rating on many companies it follows, especially those in suburban markets.

Chicago-based Equity Office stock is down 5.7% this year and fell 31 cents to $29.75 on Thursday, while Arden is down 8.1%, rising $1.06 to $28.63. Boston Properties is up 6.8% and fell 13 cents to $35.31. Both stocks trade on the New York Stock Exchange.