The popular US nonfarm payroll employment number beat expectations in July, posting an increase of 209,000 jobs versus the 183,000 forecasted figure. Although down from the previous month, the result was over 14% better than anticipated, and continues to add fuel to the view that the macro-economy is solid (for the moment).
The result was also strong enough to impact the total unemployment rate figure, helping nudge it down to 4.3% (from 4.4%), matching the 16-year low achieved in May of this year. While this type of news is good for the economy as a whole and again great for real estate across all sectors, these type of employment gains usually have a more immediate effect on the office component of the real estate market.
Growth in office sector a tale of two cities
Job gains are highly correlated with demand for office real estate, and therefore as demand increases, so do the prospects of office REITs. However, the following graph depicting rental growth in the major US Gateway Cities (major cities of entry and exit to the United States including Atlanta, Boston, Chicago, Los Angeles, New York, San Francisco and Washington DC), Secondary Cities and the National average, show a negative trend emerging over about the last two years.
Ceteris paribus (Latin for "Other thing held constant or equal"), this should come as a surprise to investors, as US rental growth enjoyed over 4% year-on-year increases from 2014 up until the middle of 2016. Then, as if the sector were impervious to improving employment numbers, the year-on-year figures took a dive and are now under 1% for Gateway Cities. Note however, that the Secondary Cities’ (Austin, Dallas, Denver, Houston, Nashville, Phoenix, San Jose, Seattle and Tampa) number is still above 4%, a far more impressive performance.
The difference between these two geographical baskets (Gateway vs Secondary Cities) highlights an interesting development in the office retail space. New York financial sector jobs were effectively flat for 2016 and the majority IT-comprised San Francisco office market also slowed dramatically over the same period. Consider that close to half of the total value of US office real estate is situated in the Gateway Cities basket, and it becomes clearer how the national average is weighed down by these underperforming mega regions.
Of much interest is the demand/supply dynamics found in these different markets. The Gateway City dynamics are still weak compared to pre-financial crisis years. Demand (depicted by the blue Net Absorption line) is still yet to reach half of the levels seen in 2006 and 2007. While it is true that new office building completions (depicted by the red Net Completions line) in the first half of this year were 35% higher than over the same period last year (2016), developers can hardly be scolded for over-producing. The second quarter Net Completions figure for example, is ranked 19 out of the last 48 quarters on record, hardly an extravagant output level.
Then take a look at the graph below, also depicting demand/supply dynamics, but this time in Secondary Cities and Tertiary Markets (the next 31 largest metros in the US). The absorption rate has been steadily climbing to pre-financial crisis levels and have posted a higher number than Net Completions for 24 consecutive quarters. Growth of office employment outside of the main cities has outpaced the national average of the last few years, and the trend looks set to continue for the short to medium term.
REIT managers fully aware of the geographic divergence
REIT managers as a whole have been increasing their square metre footprint in Secondary City office markets at a rate of 4.5% per year over the last 10 years (2006-2016). This, compared to the Gateway City square metre growth, coming in at less than half this figure.
REITs clearly appear to have had their finger on the pulse, and had foreseen the more attractive fundamentals stacking up in favour of the Secondary City office sector. This has ultimately meant that investors benefit, and further highlights the key role of research and of the REIT manager in the search for stronger performance.
REITs Increase their Position within Secondary Office Markets as Demand Grows - Alexandra Thompson
Job Numbers Bode Well for Office REITs - Calvin Schnure
Investment Specialist at Discovery Invest
Mark graduated with a Business Science Degree from the University of Cape Town in 2007. He then joined Sharenet, during which time he also completed his B.Com Honours through UNISA. Mark has helped to build, launch and manage derivative and share trading brokerage businesses. He is also a JSE Registered Securities Trader, and has worked on the trading desk at Sharenet. After seven-and-a-half years at Sharenet Mark then moved to Reitway Global (a specialist Global Listed Property Fund Manager) where his passion for property was further kindled. Mark currently works for Discovery Invest as an Investment Specialist on their Investec Managed fund offering. He has over ten years of experience in the equity and asset management sector and can be reached at: firstname.lastname@example.org
The views and opinions (where expressed) in this article are those of the author and do not necessarily reflect the official policy or position of Discovery Invest.