Demand and Diversification in Office Space

During her keynote presentation at NAIOP’s National Forums Symposium last week, Mary Ludgin, managing director, head of global research for Heitman, market, noted that the market is positioned for positive growth. In part two of this series, discover what Ludgin predicts for future office demand. Click here to read part one: The Real Estate Market’s Sweet Spot.

Future Office Demand
In the office product area, Ludgin stated that in contrast to the sharp upturn in the industrial sector, office has been a much slower ride, but that is changing now. She noted that 2014 was the last sluggish year and that 2015 is going to be a very good year from an office demand perspective. In both of those years there was good investor demand, but not so great tenant demand.

In 2015, Ludgin says there will be good numbers for both investor and tenant demand. She reports that vacancy remains relatively high, but it is coming down and that will continue in 2015 and beyond because construction remains extremely muted. She notes that because construction remains muted, all sorts of investment strategies that involve varying levels of risk can be executed.

With regard to office demand going forward, Ludgin noted that central business districts that have transit and residential space will have millennial demand. At this moment in the cycle, office location decisions are made by the head of human resources (HR) based on where they believe they can capture the talent needed for the business rather than what the accounting person says.

She added that with unemployment below 5.5 percent, which is coming close to full employment, it is the HR group that dominates those location decisions. This means highly-sought office locations will be primarily metropolitan areas that have viable downtowns.

She acknowledged, however, that a broad swath of the country does not have healthy downtowns. For example, she pointed out that Phoenix will not suddenly become a downtown-dominated office market. Ludgin confirms that the “end of the suburbs nonsense” is just that. There are whole sections of the country where the car will remain the way people get to and from work, and in those locations, suburban is as viable as downtown.

Diversification in Medical Offices
Ludgin noted that Heitman has diversified office exposure with medical office because medical office behaves differently than commercial office. Medical office does not move with the economic cycle from a space demand perspective. She noted that while you cannot push rents to the extent you can in commercial office during those bright moments, slow and steady wins the race in medical office. With 10,000 baby boomers turning 65 every day, there will be increasing demand for medical office as the sizable generation ages.

While extolling the virtues of the current market, Ludgin closed the session by reminding NAIOP members to pay attention to three key themes:

  1. Keep an eye on the clock. Ludgin notes wryly that we’ve not learned how to manage the economy well enough to avoid a recession so keep your eyes on the clock. The United States is late in its economic cycle so it is a risky time for ground-up office development.
  2. Construction has been minimal in many markets. A lack of new supply creates potential for development, renovation and lease up strategies.
  3. When risks abound, follow the known. Diversify and focus on demographically-based strategies or locations poised for market share gains.

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