Battle of wills underway in national office market.

Now that U.S. has had time to settle since the onset of the subprime crisis, 2008 1Q data is revealing which office markets were first to feel the heat of the real estate industry's slowdown. Though firms are reporting a modest rise in vacancy rates nationwide, commercial prices--in most markets--have yet to falter.

According to Colliers ABR, the office vacancy rate increased for the second consecutive quarter, reaching 12.77% overall, while U.S. suburban markets spiked to 13.8%. The report broke down vacancy rate at 11.76% for class A space, with class B and C properties checking in at 13.64%. But despite more increasing availability, pricing has held its own. The firm reported a 2.6% increase in class A downtown rents, which now average $49.84 psf nationwide. "Despite the abundance of bad news experienced by the financial markets in the first quarter, the office real estate market now finds itself engaged in a battle of expectations," said Ross Moore, senior vice president and director of market and economic research at Colliers. "Tenants see a faltering economy and as a result expect lower rents, while landlords feel confident with occupancy rates still near historic highs, giving them the leverage to push rents higher."

Downtown vacancies showed signs of stability in most U.S. markets in the first quarter, but suburban areas have taken the biggest hit thus far: of 53 suburban markets monitored by Colliers, 39 had rising vacancy rates. And Moore expects the first half of the year will remain quiet for the "lion's share" of U.S. cities.

Thus far, Florida commercial markets appear to be the hardest hit. According to Colliers data, the Tampa vacancy rate climbed from 13.5 (in December 2007) to 15.1% by the end of March 2008. In West Palm Beach, vacancy increased from 12.7% to 14%, while Orlando experienced a jump from 6.2 to 7.6%. But the Kansas City market lays claim to the nation's highest vacancy rate, at 21.3%, followed by the Dallas/Ft. Worth market at 21%.

But a few markets showed signs of improvement. Vacancy rates in Denver dropped from 12.4 to 10.5%, while Detroit--previously home to the nation's worst vacancy rate--plummeted from 26.8 to 17%. But the North Carolina markets of Raleigh and Charlotte remain some of the tightest in the country; Raleigh's vacancy rate dropped from 6.9 to 5.3% and Charlotte dipped to 2%.

According to Grubb & Ellis 1Q figures, other markets are showing signs of trouble as well. Austin, Texas recorded the largest vacancy rate rise (from 12.8 to 15.9%) of the 57 markets tracked by the firm. Of those 57 markets, 42 experienced rising vacancy rates. And Austin's woes are echoed in Phoenix and Orange County.

Grubb & Ellis reports that the South Carolina markets of Greenville and Columbia recorded significant drops in vacancy rates, while Pittsburgh, San Francisco and Fresno, Calif. figures demonstrate healthy markets there.

The firm's 1Q report suggests that the U.S. economy may have already slid into a recession. It estimates the economy could see approximately 200 million layoffs, which would equate to a negative absorption of 100 million square feet of office space. Grubb & Ellis forecasts the nationwide office vacancy rate could peak at 18% by the end of 2009 (as it did in the third quarter of 1991 and the first quarter of 2004).

The analysis also suggests that the capital markets remain "dysfunctional," meaning equity capital and nicely priced debt may not be able to save commercial real estate from the downturn, as it has in the past. And as more properties hit the market, it could pave the way for increased investment opportunities and bargains for tenants. But there's little evidence of that happening in the New York City market.

According to The Staubach Company's statistics, New York has seen job growth of 1.1% over the past 12 months, despite financial sector layoffs. Manhattan appears stable and remains characterized by little sublease space and a tight office market. While the firm predicts a softening of commercial leasing over the next two quarters, it suggests stability and growth returning to New York by the end of the year, heading into 2009.