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SALT LAKE CITY — Living in Utah, it's not uncommon to hear good economic news. In fact, sometimes it can seem a little hard to believe, because everybody knows someone who couldn't find work or continues to struggle to make ends meet. While it's true that tough challenges continue to confront families and individuals across the state, generally speaking, economic conditions are improving.
As the senior analyst in CBRE's Salt Lake City office, I look at commercial real estate trends and markets. Many people might wonder what that has to do with the economy. At my firm, people frequently refer to commercial real estate as the "economy in a box". Essentially what that implies is commercial real estate literally houses organizations of commerce. Businesses are consumers of commercial space. Consequently, much can be learned about a local economy by looking at commercial real estate. In Salt Lake, the commercial real estate market is telling us there is reason to be optimistic about current and future trends. While there was improvement in the industrial, retail and office markets, progress in the office market was particularly notable during the first quarter of 2013.
In Salt Lake, the commercial real estate market is telling us there is reason to be optimistic about current and future trends.
The primary risk to the commercial real estate market at the beginning of the year was the fiscal cliff due to the magnitude of problems it had the potential to create. Although the large "cliff" was avoided, the implementation of sequestration could prove to be problematic, especially with regard to defense cuts. In fact, although spending cuts in sequestration were designed to be split evenly between defense and domestic programs, its impact will be felt unevenly in metro areas across the country. Cuts to defense represent the greatest immediate risk to current conditions propelling local commercial real estate going forward. However, our firm believes Salt Lake's office market performance will be supported as the national economy improves, particularly toward the end of the year.
Demand Driver
The primary demand driver for office space comes from the need to house workers in the professional and business services sector, as well as the financial sector. Looking at the latest employment data, it is clear Salt Lake's office market is responding to strong demand.
According to the Bureau of Labors Statistics (BLS) data for Salt Lake, over the 12 month period ending in February 2013, employment in professional and business services expanded by 3.5%, at the same time financial services grew by 6.9%. Impressive employment growth created strong demand for office space.
The primary demand driver for office space comes from the need to house workers in the professional and business services sector, as well as the financial sector. Looking at the latest employment data, it is clear Salt Lake's office market is responding to strong demand.
Key Indicators
When looking at commercial real estate there are four major indicators most widely observed: net absorption (measurement of rate at which space is leased - also taking into consideration space vacated), vacancy, average asking lease rates and construction of new space. A quick analysis of Salt Lake's office market shows all major indicators improved during the first quarter.
In fact, net absorption was almost four times higher when comparing the first quarter of 2012 to the first quarter of this year. This positive net absorption was experienced county-wide in all property classes. However, it is worth noting that special one-time factors and large transactions boosted net absorption above the expected trend during Q1. Even still, the trend of market-wide positive net absorption is expected to continue throughout 2013.
During the first quarter of 2012 vacancy declined significantly, falling 180 basis points from 15.8% to 14.0%. The decline in vacancy can be attributed to strong demand (represented by positive net absorption) and the sale of two buildings, which will be taken off of the market for dedicated usage (effect of shrinking supply). These two factors combined created a potent combination and brought vacancy down at a more rapid pace than previously anticipated.
Average asking lease rates are also up. The average asking lease rate in Salt Lake's office market increased 2.8% on a year-over-year basis going from $19.29 per square foot at the end of Q1 2012 to $19.83 for Q1 2013. Looking ahead, limited amounts of completed construction during the next several quarters and steady demand will continue to place upward pressure on lease rates, particularly in high-demand areas.
While the metro area's outlook is promising, it is dependent upon an absence of major policy errors or external events that could prove to be highly disruptive to the economy and by extension, commercial real estate.
With regard to new construction, several new office projects are underway in the Salt Lake valley. However, due to the large nature of these commercial projects and time required to finish them, completed construction is not expected to reach 2012 levels. At the present time, there is 422,364 square feet of multi-tenant office space under construction that will enter the market upon completion.
Outlook
While the metro area's outlook is promising, it is dependent upon an absence of major policy errors or external events that could prove to be highly disruptive to the economy and by extension, commercial real estate. Policymakers in Europe recently reminded businesses and investors alike how quickly policy errors can change market risk perceptions after a bungled response to problems in Cyprus. Meanwhile, headlines out of North Korea and the Boston Marathon bombing provide reminders of an uncertain world where unforeseen events with broader impacts can occur at anytime. Furthermore, the debt ceiling issue in the United States will need to be addressed again in coming months. With so many things that can go wrong, one would hope that American leaders do not manufacture unnecessary challenges.
Although there are some near-term risks to the metro area's economic performance from the effects of sequestration and other unknowns, favorable conditions are expected to continue. In summary, there is good news on the economic front in Utah and that is reflected the Salt Lake metro's commercial real estate market. However, recent events remind us that there is no time for complacency in the world we live in.
