Owners start to see returns, but speculative building is unlikely.

The Studley Effective Rental Index (SERI) released this month by the commercial real estate firm of Julien J. Studley, Inc. reflects an improved U.S. commercial real estate market, with rental rate increases occurring in most major Central Business Districts.

"Most significant," says Julien Studley, president and chairman, "is the occurrence of a slight shift in the balance of power between tenants and owners, with landlords finally gaining some ground in the marketplace. In many markets, the total rent has remained relatively constant over the last year, while there has been a significant drop in the value of the concession packages offered by landlords. This is indicative of a shift in both the marketing strategy and market strength of owners." However, adds Studley, "There is still not a single market where the owner's return exceeds replacement costs, and therefore, justifies new speculative construction."

The Index is a comprehensive analysis of effective rental rates for Class A properties in 12 major office markets across the country. The primary objective of the Index is to identify both the tenant's true cost of leasing office space (Tenant Effective Rent) and the landlord's true income before debt service (Landlord Effective Rent). Tenant Effective Rent is defined as the tenant's projected average annual expenditure (on a rentable per square foot basis), less the value of landlord concessions such as free rent, construction allowances or other provisions. Landlord Effective Rent is defined as the total rent, less expenditures for operating expenses, real estate taxes, electricity, concessions and commissions. The Landlord Effective Rent is exclusive of debt service.

The SERI provides actual, specific statistics on commercial real estate rents and costs - information which is critical to sound leasing and purchasing decisions. This analysis differs considerably from the often-quoted "asking rental," which does not reflect the actual terms of a concluded transaction, excluding, for example, the greatly varying amounts of concessions granted.

Those cities included in the survey are Atlanta, Baltimore, Boston, Chicago, Houston, Downtown Los Angeles, West Los Angeles, Downtown New York, Midtown New York, Philadelphia, San Francisco and Washington, D.C.

"Of the 12 markets surveyed, Midtown New York and Washington, D.C. are the strongest markets nationally, and are commanding the highest rental rates from tenants and delivering the highest returns to landlords," said Studley. According to the Index, Midtown New York experienced the biggest jump in tenant effective rental rates, increasing $4.05 per rentable square foot, from $31.58 in 1993 to $35.63 in 1994, as well as in the landlord effective rental, increasing $3.74 per rentable square foot, from $11.81 in 1993 to $15.55 in 1994. Downtown New York, still lagging far behind Midtown (and many of the other surveyed markets), did, however, show a slight uptick in both rental measurements, with the tenant effective rent equaling $23.24 per rentable square foot, and the landlord effective rent equaling $7.28, at the close of 1994.

The statistics reflect increases in tenant effective rentals in 10 of the 12 markets surveyed, and increases in landlord effective rentals in 9 of the 12 markets.

"While effective rental rates may be creeping upward, and owners can certainly say they are better off today than one year ago, the numbers are still far too low to justify new speculative construction," emphasized Studley. "In fact, Washington, D.C. is the only market where development is presently underway, and even there, projects have to be at least 50 to 75 percent leased before breaking ground."

According to the survey, Philadelphia, Chicago, Houston, Baltimore and Downtown Los Angeles are among the nation's weaker markets. Furthermore, Downtown Los Angeles is the only market included in the Index where the landlord effective rental is below break-even, equaling a loss of ($0.26) per rentable square foot at the close of 1994. The Chicago market, although still relatively weak, witnessed an increase in the landlord effective rental from a negative to a positive number over the last year.

Atlanta and Boston showed surprising strength over the last year, with both cities experiencing a significant surge in leasing activity, and, consequently, an increase in rental rates. Noted Studley, "Underscoring these markets' 'sleeper' status is the fact that for relatively low-cost locations, the landlord return is exceptional, equaling $11.50 per rentable square foot in Atlanta and $11.42 in Boston."

"Corporate America instituted significant cutbacks during the past few years, but now many companies are actually in a growth mode," said Studley. "Tenants could find themselves running short of space just when the rents move up. There are still opportunities for good expansion space, but it's a small window."

Key Research Findings

Tenant Effective Rental Rates: Overall, tenant effective rental rates range from a high of $35.63 per rentable square foot in Midtown New York to a low of $11.61 in Downtown Los Angeles.

The greatest increase in tenant effective rentals over the year occurred in Midtown New York, with an increase of $4.05; followed by Washington, D.C., with an increase of $3.37; and Boston, with an increase of $3.18.

Decreases in the tenant effective rentals were evident only in Baltimore and Philadelphia.

Landlord Effective Rental Rates

The greatest increases in landlord effective rentals from 1993 to 1994 occurred in Midtown New York, with an increase of $3.74; Washington, D.C., with an increase of $3.68; and Chicago, which rebounded $2.96 from below break-even to a positive return of $0.58 per rentable square foot. Of the markets surveyed, Downtown Los Angeles is the only city where the landlord effective rental is below break-even, currently equaling ($0.26) per rentable square foot.

Slight decreases occurred in Baltimore, Houston and Philadelphia.

Concessions

Concession packages are the most generous in Downtown Los Angeles, at $92.50 per rentable square foot. Concessions are also high in Downtown New York, at $80 per rentable square foot.

Concessions decreased in all of the markets surveyed, with the exception of Philadelphia, where the value of the concession package remained unchanged from 1993 to 1994. The sharpest drop occurred in Chicago, where concessions decreased by $40 per rentable square foot over the year, from $90 in 1993 to $50 at year-end 1994.

Costs

Operating expenses range from a low of $3 per rentable square foot in Houston to a high of $7.60 in San Francisco. Operating expenses increased in seven of the 12 markets surveyed, and remained unchanged in four markets. Washington, D.C. is the only market which reflected a decrease.

Real estate taxes range from a low of $2.25 per rentable square foot in West Los Angeles to a high of $9.35 in Midtown New York. Taxes are also high in Chicago at $7, and Washington, D.C. and Downtown New York at $5.75.

Slight increases in electric costs occurred in eight of the 12 markets surveyed while costs in three of the markets remained unchanged from 1993 to 1994. Atlanta experienced a decrease of $0.10 with costs equaling $1.30 per rentable square foot at the close of 1994. Electric costs ranged from a low of $1.10 in Boston to a high of $2.18 in Midtown and Downtown New York.

For reference in comparing office rental rates nationwide, the loss factor (defined as the percentage difference between the tenant's rentable area and the tenant's usable area) for each market included in the survey is as follows: Atlanta 27 percent, Baltimore 12 percent, Boston 14 percent, Chicago 11 percent, Houston 12 percent, Downtown Los Angeles 10 percent, West Los Angeles 12 percent, Downtown New York 27 percent, Midtown New York 27 percent, Philadelphia 12 percent, San Francisco 13 percent, and Washington, D.C. 10 percent.