by Calculated Risk on 4/05/2011 03:27:00 PM

Earlier this morning Reis released their office vacancy rate report for Q1 2011. Reis reported that the vacancy rate declined slightly to 17.5% in Q1 from 17.6% in Q4 2010; the first decline since 2007.

So when will non-residential investment in office structures start to increase? Short answer: Probably not for a couple of years.

Click on graph for larger image in graph gallery.

This graph shows office investment in real dollars (left axis in blue) seasonally adjusted annual rate (SAAR), and the office vacancy rate from Reis (right axis in red).

The two arrows point at two previous periods when investment picked up as the vacancy rate declined. In the mid-'90s, it isn't clear if we should say investment picked up at the beginning of '95 or '96, but it was when the vacancy rate was around 13% or 14% and falling.

In the mid-'00s, real office investment picked up at the end of 2005 when the vacancy rate had declined to around 13%.

So investment will probably pick up when the office vacancy rate declines to 13% or 14% (from the current 17.5%). Based on the previous two episodes of high vacancy rates, it will probably take about 2 to 3 years until the vacancy rate falls that far.

On the plus side, the recent office investment bubble was nothing like the S&L driven bubble of the '80s or the stock market driven bubble of the late '90s. Also the level of current investment is at a historic low in real terms. And that would suggest the vacancy rate might fall faster this time.

Note: see this graph and this post for investment in offices, malls and hotels as a percent of GDP since 1959.

Unfortunately employment growth will probably remain choppy and sluggish until residential investment picks up (and that will not happen until the excess vacant supply is absorbed). Office space is absorbed as employment increases, and sluggish employment growth suggests it might take longer for the vacancy rate to fall.

So the low level of investment suggests the vacancy rate will fall faster than earlier periods - and sluggish employment growth suggests the vacancy rate will decline slower - so I'd say about two year until investment picks up (maybe more). Also, the decline in the vacancy rate suggests that office investment will stop declining soon - and declining office investment has been a drag on real GDP growth for eleven consecutive quarters.