The U.S. office market, which has been a welcome port amidst the nation's stormy housing industry, may now have reached a turning point. The coming downturn won't be good news for the nation's furniture industry, which has increasingly looked to commercial markets for expansion opportunities.

Office vacancy rates, which measure the percent of office space currently available and not leased, have declined since late 2003/early 2004 when they reached a peak of 18.2 percent in suburban markets and 14.7 percent in downtown metropolitan areas. Now, those rates may be starting to head back up. In the first quarter of 2008, suburban vacancy rates climbed to 14.9 percent, up from a low point of 13.6 percent in the fourth quarter of 2006. Downtown vacancy rates, which typically lag the suburban market, continue to decline, but are barely inching down at this point. Rates slipped to 10.2 percent in the first quarter of 2008 from 10.3 percent in the fourth quarter, and 10.8 percent a year earlier.

Downtown markets next

With employment now on the wane and unemployment rising, even downtown markets will soon feel the tug. Job creation is critical to the office furniture industry, since it is the mechanism that generates the demand for new furniture and fixtures. Unfortunately, in the first three months of 2008, payroll employment declined by 232,000. Private sector employment (without government jobs) declined by an even more devastating 286,000. These declines pushed the unemployment rate up to 5.1 percent in March, the highest it has been since September 2005 (following Hurricane Katrina's destruction).

Vacancy rates are also governed by the amount of new supply (office completions) coming into the market. While additions to new space have been moderate and well under control in recent years, supply is facing constraints this year as the economy slows and financing becomes tighter. The U.S. Commerce Department reports that spending for new public and private office construction peaked in October 2007 at just under $70 billion and has pulled back about 4 percent since that time. Further declines are likely through the year, which will bring office construction spending down about 1 percent from last year's total.

The silver lining

Fortunately, vacancy rates aren't uniform across the country. In some downtown areas, rates remain quite low and should accommodate further growth and development. In downtown Charlotte, for example, office vacancy rates fell to just 1.2 percent in the first quarter of 2008, making this a city that is ripe for new office development. Even in Manhattan (both midtown and downtown), rates are hovering at 5.0-5.4 percent. Rates downtown continue to fall, although midtown rates have begun to move upward. Still, rates are low enough to support new development such as the massive new towers that broke ground earlier this year at the former World Trade Center site.

At the same time, several metropolitan areas should probably avoid development in the near term, including central and northern New Jersey where vacancy rates have spiked climbing 4.7 points and 3.1 points respectively in the most recent quarter. Detroit is another metropolitan area that will probably not see much new construction in the coming year: office vacancy rates in this metro had reached 25.8 percent in the first quarter. Vacancy rates in Dallas/Fort Worth (21.6 percent in the first quarter) and Atlanta (19.3 percent) remain stubbornly high, but employment gains in these metros make them attractive for new development despite those rates. Therefore, while the overall office market has likely peaked and will head lower this year, there are always niche markets that can feed the need. It will just be harder to find them over the coming year.

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