The Office Market Outlook

The Atlanta office market’s expansion phase should continue in 2008, but at a much more subdued pace. An abundance of recently announced projects – as well as those already in the development pipeline – will ensure that overall spending for new construction rises, even as the number of new project announcements declines.

Three straight years of solid growth in office-based employment lowered Metro Atlanta’s office vacancy rate to 17 percent from its peak level of 23 percent. Given the amount of new space added to the market, that’s an amazing accomplishment.

Still, Atlanta’s vacancy rate is among the nation’s highest. Given investors’ new aversion to risk, that could become a more significant problem.

vSince 2002, investors’ demand for Atlanta’s office buildings has been exceptionally strong and clearly not deterred by all the empty space. The abundance of relatively inexpensive capital, a high tolerance for risk, heightened demand by tenants for more space, plus a consensus view that Atlanta’s economy was fundamentally strong, were among the factors fueling new office development, driving up the prices of “trophy” office buildings and lowering capitalization rates.

Although investors have been keen to purchase Atlanta’s higher quality office buildings, I am concerned that their overall appetite for these properties is sated. That’s partly because I believe the housing recession will tarnish the overall appeal of real estate as an investment. As investors become more cautious, office property valuations are likely to rise more slowly, or to simply flatten. In contrast, the appeal of lower quality properties could grow.

Still, Atlanta’s economy and its job growth prospects are even stronger than they were this time last year. Net absorption of vacant office space is likely to increase.

A strong global economy in combination with further declines in the value of the U.S. dollar relative to many foreign currencies should stimulate foreign investors’ interest in U.S. office buildings. Such investors will focus on markets such as Atlanta, with solid growth prospects and vigorous links to global supply chains.

Yet my gut tells me real estate investors are on the verge of becoming much more discriminating in their risk taking. Capital is likely to become slightly – not dramatically – more expensive. Such trends do not favor new office development projects, especially in markets with sky-high vacancy rates.

Because Atlanta’s job outlook is so good, I expect most of the already announced office development projects will go forward, but pre-leasing probably will become a more important factor in obtaining financing. I strongly suspect the number of newly announced office developments is poised to turn downward.

It will take a few years to reduce vacancy in Atlanta from 17 percent to a more reasonable 12 percent level. The increase in merger and acquisition activity that Atlanta experienced in 2006-07 – Georgia Pacific, BellSouth, Scientific Atlanta – will continue to dump space onto Atlanta’s saturated office market.

Consequently, I am not looking for meaningful improvements in rental rates. Increases are more likely to pace – rather than outpace – inflation.

Compared to many major metropolitan areas, Atlanta office rents are a bargain and will remain so for an extended period. That’s obviously a big problem for the owners of office buildings. It also should be a problem for investors and developers. But it represents a golden opportunity for the state to aggressively recruit new businesses. It’s hard to think of another large U.S. metro area where the prospects for economic growth are so strong and office rents are so low.

Atlanta’s industrial property market is similar to that of the office markets. Absorption and deliveries have been and continue to be strong, but vacancy rates also are high – 13 percent in the Atlanta area. Consequently, rents are relatively stable at depressed levels.

An abundance of speculative construction took place in 2006-07, but I expect less new speculative construction in 2008. The ebbing of new construction reflects the re-pricing of real estate risk, pressures on development costs, as well as an excess of ready-to-lease space.

Because more companies will relocate or expand to Atlanta and Georgia in 2008, demand for new industrial space will be on the increase, but probably will not rise quickly enough to significantly outpace the new supply entering the market.

Categories: Economic Development Features, Features