ONCOR predicts continued positive market.

Mirroring a display of encouraging economic indicators, North American office markets ended the year with a millennium-hyped fireworks show of their own, according to David A. Ball, president and CEO of ONCOR International.

According to ONCOR International's just-released "1999 Year-End North American Office Market Report," the most spectacular starburst was a meteoric second half rise in overall occupancy gains. North American markets absorbed a decade topping one-year total of 81.3 million square feet of space. This represented a throwback to 1997, when the markets absorbed 79.6 million square feet. In between stands 1998, when absorption levels dropped to a troubling 57 million square feet.

Looking back, 1996 was pretty dismal, too, with total absorption well under 60 million square feet. This means that the last four years have followed a very distinct up and down pattern, with absorption rising and falling by a whopping 33 percent average in alternate years. Should this trend continue, the first year of the new millennium would be an off year, with absorption precipitously dropping again. Will it happen?

ONCOR's local forecasters in the 46 markets they, survey generally don't think so. A compelling 95 percent of them feel that their respective Central Business Districts (CBDs) will either register increased absorption over 1999 levels (36 percent) or see absorption levels remain about the same (59 percent). ONCOR forecasters were even more optimistic about gains in overall occupancy outside their CBDs, with 53 percent predicting increases and 40 percent predicting holding even.

Their opinions are based on more than hunch. Total inventory in North American office markets grew by 138 million square feet during 1999. That represents less than two years of supply at the 1999 absorption rate - so supply isn't running out of control. From another angle, it would take 3.9 years to exhaust existing unoccupied space (fresh supply plus old inventory) ready for lease today. Relatively speaking, that's not too bad either.

In analyzing absorption mechanics, what's interesting is that 24 percent of total 1999 absorption involved B grade or lower space. Class A markets absorbed 61.8 million square feet, representing a 2.3-year supply of unoccupied premium inventory. This suggests that lower grade properties are benefiting from a tightening of availability in the high-end market - another good sign. It could also imply that cost-conscious tenants are choosing Class B stock even when Class A space is reasonably plentiful.

This interplay between different classes of space would suggest that Class A rents are rising, and indeed they are. The aggregate average of Class A rental rates in the 46 markets surveyed by ONCOR increased by 3 percent in both the CBD and non-CBD study areas during 1999. CBD rental rates are up 10 percent over the past two years, while non-CBD rates have climbed 6 percent since year-end 1997. So, the upward trend continues.

If ONCOR's analysis uncovered a wrinkle, it is that Class A rental rates are increasing in fewer markets than before. At year-end 1998, rents were on the rise in 74 percent of the cities surveyed. That figure dropped to 58 percent at year-end 1999. The pattern remains the same outside of CBDs. During 1999, rental rates increased in 49 percent of what ONCOR used to call "suburban" markets. That represents a fairly significant decline from the 75 percent reporting increases during 1998.

If fans are complaining about parity in the National Football League, they ought to begin following rental rate increases in North American markets, where huge disparities remain. Class A rents in Ottawa's CBD soared 63.6 percent last year. The goings on in Canada's capital city probably didn't assuage the pinch felt by tenants. In Boston's CBD, average rents climbed 20.2 percent; in San Francisco, 17.8 percent; and in Seattle, 16.6 percent. With inflation in check, the increases reflect landlord license during periods of low supply and high demand.

These, however, are the unusual markets. An indication that markets are beginning to loosen up due to increased supply (more likely than decreased demand in this economy) is that landlord concessions are slightly more prevalent. A year ago, ONCOR asked its local forecasters if landlords were "getting their deals" or "making minor concessions." Minor concessions were reported in just over half (56 percent) of the markets. That figure grew to 70 percent of the markets at the end of 1999.

During the last major downturn in office market health that occurred in the early through middle 1990's, the culprit was wildfire over-building during earlier, more prosperous times. An entire industry responded by promising never to let it happen again. So far, everyone has pretty much kept their word (especially the lenders) - with exceptions. Atyear-end 1999, ONCOR counted 82 buildings under construction in 27 North American CBDs, accounting for 28.8 million square feet of soon-to-be-added inventory. The square footage represents a 14.8 percent increase over year-end 1998.

What is illuminating (NFL decriers take note) is the imbalance across the markets. Fully 59 percent of space under construction in North American CBDs will get unloaded in just five markets: Minneapolis (5.6 msf), Boston (3.4 msf), Charlotte (3 msf), Chicago (2.5 msf) and Seattle (2.3 msf). Minneapolis and Boston between them account for a staggering 31 percent of the North American CBD total.

The imbalance carries over outside CBDs. At year-end 1999, ONCOR identified 857 "suburban" buildings under construction in 41 cities, representing 77.6 million square feet. That square footage is actually down 10.7 percent from construction figures reported a year ago. Eight markets (20 percent of the markers reporting construction) reported over 3 million square feet under construction, accounting for 45 percent of the North American total. The office districts surrounding Washington, D.C. can claim a 1.2 percent share of the total, displacing Dallas' suburbs as the North American top dog (or hog).

That could be too much. ONCOR regularly asks its local forecasters to handicap their respective outlooks for maintaining "healthy, growing, reasonably balanced office markets." Maybe it's millennium fever, but this year's crop is full of optimists. ONCOR local forecasters are showing more confidence than they were entering 1999, with 48 percent (up from 36 percent) saying they're "optimistic" about the year 2000. With two exceptions, the rest are all "guardedly optimistic." Washington, D.C., quite predictably, casts itself in the category "tending toward concern."

Another brightening consideration is that investors maintain a healthy appetite for office product. Office building sales activity is reported to be "strong" in 46 percent of North America's markets and "very strong" in an additional 1.1 percent. "Very slow" activity is reported only in Richmond, Winston-Salem and the Silicon Valley.

Investor interest must be fueled by long-term optimism, because bargain properties are hard to find. Office building sales prices are at "record levels" in 22 percent of the markets ONCOR surveyed (up from 16 percent a year ago) and at "near record levels" in an additional 47 percent of the markets (up from 29 percent a year ago). Only 24 percent of the markets reported prices "dropping from peak levels," indicating a widespread upswing in prices, since 55 percent of the markets reported they were slipping from peak levels at the end of 1998.

So, what's causing all the robust statistics and unalloyed optimism - millennium fever or rock-solid market fundamentals?"

"ONCOR believes it's a combination of both," said Ball. "The coming of a new millennium unquestionably put our on-the-ground market observers in a good frame of mind, but their overall optimism seems well buoyed by surging absorption, stabilizing vacancy rates (no sharp upturns), and generally restrained construction. If the fundamentals remain intact, the 1996 through 1999 alternating down-up-down-up cycle of market absorption might just get broken," he concluded.