Colliers Report: The cost of office space and improvements increase
July 18, 2018
Key Takeaways
- Rental rates are expected to continue on a gradual incline due to a tightening market and lack of new construction.
- Tenant improvements are worth the expense in order to attract the right employees.
To download the complete report: 2018 Q2 Office Columbia Report
Employment costs outweigh tenant improvement expenses
Tenants desire improvements to their leased space for a variety of reasons: to draw new talent to their business by providing collaborative space and interesting amenities; to create a workspace compatible with the type of business being conducted within the space; and to create a fresh look with updated finishes and higher-quality utilities.
Often, tenant improvements are offered by landlords to incentivize a tenant to choose one space over another; however, due to the lack of available space in Columbia and the rise in construction costs, it is a challenge for landlords to continue to offer tenant improvements in a cost-effective manner. Therefore, tenants who choose to have their space updated may be burdened with rental increases and cost sharing in order to meet improvement requirements. The price of real estate improvements are still far less than wasted employment costs when employers in dated space are unable to attract skilled employees. Therefore, tenants are more apt to pay for improvements that will attract and retain quality employees, rather than not updating their space and spending more in employment costs due to a lack of skilled employee interest.
Construction costs. Tariffs are impacting construction pricing in a dramatic way in Columbia. According to LCK, LLC, “material price increases related to tariffs will fall into three categories: direct increases on imported goods; increases on domestic material due to production overhead; and increases due to uncertainty of the market. For renovation work and tenant upfits, duct work, drywall, acoustical ceilings, and interior storefronts are expected to be the main pressure points.” However, LCK also offers alternatives in order to offset some of these construction costs so that prices may be slightly reduced, depending upon the nature of the upfit. Below are some of the material price increases affecting construction projects:
- Sheet metal (duct work): +5%-25%
- Steel pipe: +40%-60%
- Metal wall panels: +5%
- Drywall & acoustical ceilings: +25%
- Membrane roofing: +5%
Employment costs. Rising employment costs are one of the largest company expenditures and may decrease the level of revenue an employer is able to generate unless the employees are also increasing revenue. Therefore, hiring skilled new talent capable of increasing profits is vital for continuing success. According to the Bureau of Labor Statistics Employment Cost Index, employment costs have risen as follows:
Civilian Workers Thru 03/18
- Compensation costs: +2.7%
- Wages & salaries: +2.7%
- Health benefit costs: +2.6%
Private Industry Workers Thru 03/18
- Compensation costs: +2.8%
- Wages & salaries: +2.9%
- Health benefit costs: +2.5%
This means on a baseline level, 2018 employer costs will rise (8% per civilian employee and 8.2% per private industry employee) over what the employee cost was in 2017; and this does not include any specific additional expenditures which may be incurred due to bonuses or incentives. This also excludes new employee onboarding costs such as: advertising, employee referrals, travel, relocation, recruiters, legal fees and administrative fees; therefore, employers want to hire appropriately skilled employees on the first try.
In summary, while the cost of tenant improvements is rising due to the increase of construction costs, employment costs are also rising and are a larger expenditure – one where money may be wasted if tenants are unable to attract the necessary skilled employees. Tenant improvements are the easiest way to attract new workers to a fresh, updated working environment with appealing amenities in a productive, collaborative space. While the upfit costs may be shared by the tenant, it will be worth the investment in the long run and will save employers time and money when their updated space attracts the necessary talent to succeed.
Market Conditions
The Columbia office market has 16.19 million square feet within eight submarkets. The market remains very tight, with gradually rising rental rates and no new significant construction underway, nor planned. The overall market absorption was 6,445 square feet during the second quarter of 2018, mostly due to 31,344 square feet of Class A office space being absorbed, the majority of which was within the central business district. The Columbia market vacancy rate continues to slowly decline and this quarter it was 11.72%, down four basis point from last quarter and 8.22% lower than it was one year ago. The overall average market full-service rental was $16.39 per square foot during the second quarter of 2018, which remains essentially unchanged from the weighted rental rate of $16.37 per square foot last quarter.
Columbia Business District (CBD)
The Columbia Central Business District has 97 buildings totaling 5.69 million square feet within the market. The vacancy rate within the CBD dropped from 11.56% during the first quarter of 2018 to 11.36% this quarter; likewise, Class A vacancy is also lower, down from 11.21% during the first quarter to 10.12% this quarter due to 25,309 square feet being absorbed. The CBD absorbed 11,152 square feet of office space this quarter and the average weighted rental rate rose from $19.58 per square foot during the first quarter of this year to $20.48 per square foot this quarter. Class A weighted rental rates dropped slightly from $22.93 per square foot during the first quarter of 2018 to $22.32 per square foot during the second quarter of 2018. These rates fluctuate slightly, but are expected to continue to gradually rise as the market continues to tighten.
Suburban
The Columbia suburban market sector consists of 225 buildings totaling 10.49 million square feet. The vacancy rate within the suburban submarkets during the second quarter of 2018 was 11.92%; Class A suburban vacancy fell to 8.47% this quarter from 8.77% during the first quarter of 2018. Class A suburban office space absorbed 6,035 square feet from April through June of 2018; however, the overall suburban market posted a net negative absorption of 4,707 square feet. The average weighted rental rates within the suburban submarkets averaged $14.76 per square foot and Class A suburban rental rates rose from 17.39 per square foot last quarter to $19.03 per square foot this quarter for the remaining available suburban office space.
Significant Transactions
According to CoStar, the second quarter of 2018 began with 29 sale transactions varying from 265,000 square feet to 3,012 square feet. There were also 84 leases signed in Columbia from April through June of 2018, most of which were less than 10,000 square feet.
Sales
- A 265,000-square-foot Class B office building located at 1401 Shop Road and occupied by The State Media Company sold in Columbia for $16.63 million.
- Carolina Medical Plaza located at 3010 Farrow Road sold for $10 million in May.
- 1233 Washington Street is a 42,000-square-foot office building that sold for $1.95 million and will be redeveloped into a hotel.
- 1205 West Colonial Life Boulevard, a 14,210-square-foot Class B office building, sold for $1.63 million.
- The Heritage Building, located at 1777 St. Julian Place, is a 42,567-square-foot office building that sold for $1.65 million.
Leases
- In Columbia, a 22,000-square-foot office lease was signed at 7 Technology Circle.
- A 10,719-square-foot office space was leased at 714 South Lake Drive in Lexington.
- 8,842 square feet of office space was leased at 3700 Forest Drive in Forest Acres.
- Two leases were executed at 201 Executive Center Drive in Columbia: the first floor lease was for 7,588 square feet and the second floor lease was for 7,580 square feet of office space.
Office-Using Employment
Office-using employment are those jobs related to the professional and business services, financial activities and information sectors. According to the most recent April 2018 data from the Bureau of Labor Statistics, Columbia office-using employment totals 84,900 this quarter which is slightly less than the employment of 85,500 a year ago; the Columbia MSA has 600 less jobs than this time last year, similarly the combined Charleston Metro Statistical area has 800 less jobs than it did one year ago. However, this differs from the employment in the Greenville-Spartanburg-Anderson, where 2,900 office-using jobs were added. Total employment during the second quarter of 2018 was 397,300 within the Columbia Metro Statistical Area (MSA). This employment number has dipped slightly over the past year from the highest number of employees totaling 400,400 in July of 2017; however, the unemployment rate in Columbia is still only 4.2%.
Market Forecast
Due to the recent rise in construction costs, no new significant construction is planned in the foreseeable future. Going forward, tenants will begin to share more of the burden of tenant improvements. While rental rates continue to rise quarter-over-quarter, they will have to reach a much higher rate before new development becomes feasible. As the remaining availabilities are leased and the market tightens further, tenants will be left with no other option than to upgrade dated space in order to grow their workforce and attract new talent. Rental rates are expected to rise in the next few quarters as the availabilities are leased.
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To download the complete report: 2018 Q2 Office Columbia Report
