Cranes on the Horizon: Speculative Office Building Making a Comeback?

Since the recession, new office construction has slowed down considerably. Despite adding jobs, many American cities have seen few new office projects. Speculative office building — when developers begin construction without locking down the leases – has been even rarer. The times are changing, however, and the cranes are starting to be seen atop rising office towers again.

Although 2014 wasn’t a breakout year for the office market, the sector steadily improved. Numerous markets returned to single-digit vacancies. In California, Google, Yahoo, Microsoft and Facebook have built new complexes in recent years or leased tens of thousands of square feet of space. The U.S. economy has averaged close to 250,000 new jobs each month. Companies are hiring people, and filling up empty office buildings.

As vacancies have dropped, investors and developers are looking more closely at building office complexes — and not just in San Francisco, Manhattan and a few legitimately “hot” markets. In a few of the hottest markets in California, investors are also willing to risk speculative building again, which was practically unheard of after the recession.

Speculative Office Building Returns to San Francisco, Other Cities

In several California cities, however, the demand for office space has been clear, and the lenders and investors are freeing up more money for these projects. In San Francisco, which has been vying with Manhattan as the top office market in the country, six office buildings ranging from 176,500-to-1.4 million square are under construction. In the Peninsula market, which includes Palo Alto, four buildings ranging from 85,000-to-455,000 square feet were scheduled to open later this year.

None of these buildings have had any trouble finding tenants. According to the Cushman & Wakefield study, four of the five buildings coming online in San Francisco in 2015, are 100 percent leased. In San Jose, several office parks were constructed on speculation. The buildings were entirely leased six months before opening. All this implies that the supply of office space isn’t keeping up with the demand. These markets are ripe for more building.

Builders Remain Cautious of Speculative Office Building

It isn’t that surprising that office markets have been doing well in the Bay area, now the epicenter of the technology sector. Tech firms have shown an insatiable need for office space. Some markets that can’t really be called “hot,” however, have also started to see some speculative office building. By some reports, Los Angeles still has an overall office vacancy rate of more than 15 percent. The city, though, is seeing considerable building this year in areas where vacancies have dropped into the single digits. According to one study, the city will add 1.5 million square feet of office that doesn’t have preleased commitments, a sign that developers are confident that they can find tenants quickly.

Generally speaking, though, investors and commercial lenders remain ultra-cautious about building new office space around the country. That’s because the demand hasn’t been that strong. The sector suffered from over building in the lead up to the crash. Once the recession hit, companies eliminated jobs and also shed space by adopting open-floor plans and reducing cubicle sizes and personal offices. All this means that companies have had a glut of available office space to lease.

It is also much harder to forecast the demand for a new office building than say, a warehouse, which can be built within six months. Office projects, like hotels, take more lead time, typically as much as two years to complete. Most of the office space that has been financed since the recession has been heavily preleased before the construction begins.

Most studies suggest that investors and developers will remain cautious of office projects through 2017 and won’t do much speculative office building outside the Bay area. The future, though, seems bright for California’s office market. Not only is the overall economy improving, California’s technology industries don’t show any signs of slowing down. As more office space is absorbed, more buildings will be needed. This should present ample opportunities for landowners, investors, builders and the developers of these projects.

Since the local markets vary so much, developers and investors need to know where and when to pull the trigger on a building project. They should not attempt to do this evaluation alone. A commercial real estate expert that knows the trends in the local markets and the real estate stock can help gauge demand, and assess the competition and future prospects of a new building.

If you are considering an office project, you don’t have to go it alone. You can get a thorough analysis of the market with all the available options from a consultant whose community values align with your own. Contact DCG Strategies today to learn more.