Small businesses and medical owner/users dominated Frederick’s office market during the third quarter of 2013.
The office market lingers in the doldrums, even as the remaining segments of Frederick’s commercial real estate market have shown signs of sustained recovery. This is due to several factors:
- dependence on government employment and spending in this region;
- the loss in Frederick of several large office-using employers that left substantial pockets of vacant office space; and
- continued rapid evolution of business office use.
The silver lining in this uncertain economic environment is that corporate profits are now at 12.5% of GDP, the highest level ever recorded. When (if?) we do begin to get some clarity on how congressional budget issues will be resolved–and when quantitative easing will begin to wind down–U.S. corporations as a whole are in fine shape to ramp up hiring and investment.
In the meantime, here in Frederick, the office market had a relatively quiet quarter. The chart below outlines a few big-picture stats on the office market’s 3rd quarter 2013 transactions:
As you can see by the average square footage of the offices sold and leased during the quarter, the small business owner/user dominated activity in the market. This is consistent with what we are seeing on the street, as well.
Institutional and local investors aren’t seeing the return in local office buildings right now (with the exception of medical office buildings) and are focusing instead on multifamily and industrial properties. Owner/users (particularly medical), on the other hand, are finding that favorable prices, low interest rates and ready capital make purchasing a viable option over leasing.
Rumblings that the Fed may be considering (possibly, someday) a scale-back on quantitative easing has also put some urgency into the market. Prices on a per-square-foot basis inched up about $10/SF over the 3rd quarter of last year. (Given that there were only a little over a dozen transactions both quarters, this is not robust data, but hopefully a start to a trend. We’ll keep an eye on it.)
The commercial leasing market is much harder to pin down accurately than sales transactions. Commercial real estate agents are loath to share lease rates in order to protect their landlords and their bargaining positions.
While CoStar is estimating the average lease rate for office space in Frederick at about $21/SF, on the street we are seeing the average come in closer to $11/SF for NNN leases. The abundance of vacant flex space that Frederick is still absorbing is putting significant pressure on lease rates for traditional Class A and Class B office spaces in this area. Another pressure is lease turnovers–five- and seven-year leases are renewing at current lower market rates, which are $3-$4/SF lower than the market rates were back when they were first originated.
Generally speaking, if an office space in Frederick is leased in the $20-$25/SF range for a NNN lease, it’s a medical office.
CoStar reports that vacancy rates in Frederick office space are still hovering between 14-15%. (Most Frederick commercial agents would argue that number is probably higher.) Once vacancy rates reach a more stabilized 10-11%, and the market works through its inventory of higher-rate turnovers, lease rates will stabilize and begin a sustained increase.
With 1.25 million square feet of office space to fill, and more new-build commercial office space under construction, we are more than likely still several years off from a full recovery of Frederick’s office market.
The author: Kathy Krach is a commercial sales and leasing agent with MacRo.