How to Analyze Office Building Supply and Demand

A market analysis provides useful information needed to evaluate the supply and demand conditions for particular types of real estate. For example, investors considering the purchase or development of office space value the property based on future expected cash flows generated from rent. In order to forecast future rental income, the investor or developer must evaluate how much supply exists in the market and how demand conditions will change over time. The demand must be high enough to keep occupancy and rental rates high enough so that the return meets or exceeds the investment hurdle rate.

In order to estimate the demand for office space, it is necessary to understand overall population and employment trends for the city. In particular, the analysis must consider how that economic activity translates into office demand. So, the analysis requires an estimate of office demand by industry. Some industries demand specific retail or industrial space but little office space. Other industries only require office space. The office demand forecast attempts to focus on the growth rate of employment in industries that primarily utilize office space. This case study takes data about population and employment growth in the Orlando, Florida region and applies it to an analysis of future supply and demand conditions.

Population Trends and Office Building Demand

Recent data from the U.S. Census Bureau and the Orlando Economic Development Commission lists the total population of the Orlando metro area at 2,387,138 (2016). Between 2015 and 2016, the population of the Orlando metro area grew by 2.6%. That made Orlando the fastest growing region in the United States. The Orlando Economic Development Commission estimates that population growth in the region since 2000 equates to a gain of 138 people per day.

Population growth is mostly fueled by domestic migration. Americans moving to Orlando for retirement in warmer weather or for new career opportunities account for about 40% of the population increase. International migration (mainly from Central and South America) accounts for 34% of the increase in population. People have been moving to the Orlando area due to the region’s comparative advantages (climate, entertainment and lifestyle, and economic growth). Without these advantages, Orlando would not be one of the fastest growing regions of the country. An ongoing concern for the region, however, will be the ability to generate enough economic activity to provide services and job opportunities for this growing population.

Economic Trends and Office Building Demand

Employment data from the Bureau of Labor Statistics confirms that economic growth is driving the population growth in the Orlando metro area. In fact, job growth from 2015-2016 in Orlando was over twice the national average. A strong economy and growth in the number of jobs indicates that the population should continue to grow over the next few years unless there is a major shift to the national economy or a natural disaster. Furthermore, the job growth rate of 4.22% exceeded the population growth rate of 2.6%. If the major industries in Orlando continue to grow at this pace, more new workers will need to move into the region to fill these new jobs.

Area Industry Annual Average Employment Change Employment 2015-2016 Growth Rate
2016 U.S. TOTAL Total, all industries 141,870,066 2,378,367 1.71%
Orlando-Kissimmee-Sanford, FL MSA Total, all industries 1,157,536 46,844 4.22%
2015 U.S. TOTAL Total, all industries 139,491,699
Orlando-Kissimmee-Sanford, FL MSA Total, all industries 1,110,692

In order to translate this employment growth into office demand, it is necessary to identify the industries driving that demand.  While not exact, it is reasonable to assume that the following industries are the major consumers of office space: government, information, financial services, professional and business services, and other services. In 2016, those industries comprised a total of 432,324 jobs in the Orlando metro area. Those industries created a total of 17,746 new jobs between the year 2015 and 2016, which is a 4% growth rate. Therefore, is seems reasonable to assume a growth rate of around 4% in these industries during the next few years unless there is a significant shift in economic activity.

Ownership Industry Annual Average Employment Change Employment 2015-2016
Total Covered Total, all industries 1,157,536 46,844
Federal Government Total, all industries 13,786 1,014
State Government Total, all industries 14,849 586
Local Government Total, all industries 86,375 1,472
Private Total, all industries 1,042,526 43,773
Private Goods-producing 113,104 7,874
Private Natural resources and mining 5,052 -324
Private Construction 66,175 6,884
Private Manufacturing 41,878 1,314
Private Service-providing 929,422 35,899
Private Trade, transportation, and utilities 219,205 7,049
Private Information 22,448 -292
Private Financial activities 70,887 1,340
Private Professional and business services 188,416 10,818
Private Education and health services 144,734 5,111
Private Leisure and hospitality 247,860 9,333
Private Other services 35,563 2,808
Unclassified 310 -266

Office Building Supply and Demand

A Newmark, Knight, and Frank report on the U.S. office market showed that in the third quarter of 2017 the Orlando metro area had 68,542,974 square feet of completed office space. The vacancy rate was 7%, which equates to about 63,744,966 square feet of utilized rentable area. The market had absorbed nearly 1,000,000 square feet of space before the end of 2017.

The portion of the labor force that works in office space can vary from market to market. For this analysis we assume that 50% of government workers utilize office space, and 100% of information, financial services, professional and business services, and other services utilize office space. Using this approximation, there were around 374,810 employees who needed office space at the beginning of 2017. Converting these values into the amount of space required per employee, there is a need for about 170 square feet per employee (63,744,966 sqft / 374,810 employees = 170 sqft/employee).

If the growth of these industries continues at a rate of 4% annually and space needs remain around 170 sqft/employee, it is possible to forecast office space needs for the Orlando metro area over the next few years. This chart shows the effect of an additional 1,000,000 square feet of new rentable office space in the market annually. At this rate, the demand for office space would exceed supply by 2020.

2017 2018 2019 2020 2021 2022
Available 68,542,974 69,542,974 70,542,974 71,542,974 72,542,974 73,542,974
Vacant 4,825,274 3,276,566 1,625,910 -130,773 -1,997,723 -3,979,351
Percent Vacant 7% 5% 2% 0% -3% -5%
Employees 374,810 389,802 405,394 421,610 438,475 456,014
Space Needed 63,717,700 66,266,408 68,917,064 71,673,747 74,540,697 77,522,325

Under these conditions, the office market would have the capacity to absorb around 2,000,000 square feet of new office supply per year in the Orlando metro area. Even at that rate of increase in supply, vacancy rates would still experience a decline from the current market average.

2017 2018 2019 2020 2021 2022
Available 68,542,974 70,542,974 72,542,974 74,542,974 76,542,974 78,542,974
Vacant 4,825,274 4,276,566 3,625,910 2,869,227 2,002,277 1,020,649
Percent Vacant 7% 6% 5% 4% 3% 1%
Employees 374,810 389,802 405,394 421,610 438,475 456,014
Space Needed 63,717,700 66,266,408 68,917,064 71,673,747 74,540,697 77,522,325

Another interesting point to consider, however, is how the utilization of office space has changed over the past ten years in major metropolitan areas. As rent increases and there are cultural shifts in how workspaces are defined, the average sqft per employee declines. If space per employee fell to 130 sqft in the Orlando metro area, there would be far less demand for new supply of office space. Developers and investors should be aware of these shifts in the market as well.

2017 2018 2019 2020 2021 2022
Available 68,542,974 68,542,974 68,542,974 68,542,974 68,542,974 68,542,974
Vacant 19,817,674 17,868,662 15,841,690 13,733,638 11,541,265 9,261,196
Percent Vacant 29% 26% 23% 20% 17% 14%
Employees 374,810 389,802 405,394 421,610 438,475 456,014
Space Needed 48,725,300 50,674,312 52,701,284 54,809,336 57,001,709 59,281,778

Conclusion

This example shows how to convert data about population and industry employment growth rates into estimates of real estate demand. A more in-depth analysis might consider permits for construction of new space, differential needs for specific classes of office space, and industries such as construction and medical that may have a minimal demand for office space. Another factor that can be considered is how increasing market rental rates can impact these forecasts. For example, declining vacancy rates in this second scenario would cause higher growth rates in market rent. This change would likely change the demand for office space and may cause some businesses to look for less expensive rental rates farther outside the Orlando metro area. 

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