Several economic indicators matter when gauging the health of an office market. However, the needle mover across the U.S. is, inarguably, the employment rate. When our employment base is strong, the occupancy rates, rental rates and property values rise in correlation.
During the past four years, like most of the country, the KC area has suffered from a lack of substantial and consistent job growth. As a result, the office market has been stagnant. However, the market is picking up and days of slight growth increases are nearing an end.
The U.S. Bureau of Labor Statistics reported in the fourth quarter of 2012 that the area’s unemployment rate had dropped to
7 percent, down from 8.4 percent a year earlier. This marked 24 consecutive months of job growth in the area. Perhaps the best news for the office market was that professional and business service firms in the Kansas City area showed year-over-year employment growth of 6.6 percent, compared with 3.2 percent nationally.
A deeper look at the numbers shows that despite only comprising 44 percent of the area’s work force, nearly 70 percent of the metro area’s total net new job growth came from the Kansas side of the state line. This job growth looks to be slowly translating into improving fundamentals for the office market, but it clearly is a tale of two markets.
Consistent with the employment growth data, the Kansas market posted more impressive gains. The vacancy rate declined to 15.3 per-cent, down from 17.1 percent in the fourth quarter of 2011. There was 297,780 square feet of positive net absorption in the third quarter of 2012, the largest quarterly gain over the past two years. However, the average asking rate dropped to the full-service rental rate of $18.53 per square foot, down from $19.12 in the fourth quarter of 2011.
In Kansas, the improvement isn’t just in the numbers, as there are multiple major new projects under construction. Cerner recently accelerated the timing for the second building in Village West Campus and will deliver a 330,000-square-foot office tower in early 2014. In October, Teva Neuroscience topped out its new 150,000-squarefoot building at the intersection of College and Nall. Teva expects delivery in the third quarter of 2013. The construction of AMC Entertainment’s 130,000-square-foot headquarters at Park Place is on track to be completed next month. Perceptive Software just began construction on 120,000 square feet at Lenexa City Center, and is reportedly already considering an expansion. The Park Place development in Leawood is near full occupancy. Meanwhile, Corporate Woods saw major gains in absorption as its occupancy has climbed to 90 percent, up from 85 percent at the beginning of 2012.
The Missouri market has essentially remained flat. The vacancy rate increased slightly to 17.2 percent, up from 16.9 percent in the fourth quarter of 2011. Rental rates held essentially flat a $16.80 per square foot on a full-service gross basis, excluding parking. The Missouri market showed a modest gain in net absorption, with a net gain of 86,000 square feet in the third quarter of 2012. Freight quote highlights the new construction activity with its new 200,000-square-foot building that will be delivered in the summer of 2013. But the real story in Missouri is the downtown submarket, which ended the third quarter with a vacancy rate of 22.2 percent. Several of the large, Class B office towers recorded vacancy rates greater than 40 percent. As a result, the market is beginning to see more distressed asset activity take place.
A buyer group headed by the Nightingale Group recently purchased City Center Square (656,000 square feet) through a short sale transaction. Meanwhile, Commerce Tower (438,000 square feet) sold in a foreclosure sale in December. However, there is positive news for the Downtown submarket. In December, the U.S. General Services Administration (GSA) formally issued a pre-solicitation to lease 153,000 square feet downtown. GSA intends to relocate approximately 800 employees in the fourth quarter of 2014. Competition will be fierce for the requirement as there are more than 10 landlords that could reasonably accommodate the requirement.
As we scan the overall economic environment nationally, recovery has been limited to a handful of regions dominated by oil and gas, energy and technology demand. Aside from those regions, the real estate recovery has been slow and performed lower than expectations. KC is no exception.
Despite corporations holding near record levels of cash for investment and future growth, they have been increasingly skeptical to put that cash into the market during the past six months due to slower sales growth and potential political and economic uncertainty. If the difficult, long-term policy debate and other questions are sufficiently addressed, we remain highly confident that the office market recovery will gain full steam in 2013.
While it’s unlikely that Kansas City will emerge as a high-growth market in the near future, the local office market will follow this national trend. As confidence among business leaders returns along with increased hiring, we fully expect the current growth to accelerate.