11/08/2012 | by Carisa Chappell

Amid slow job growth and a struggling economy, office REITs have struggled to gain ground since the onset of the recession. However, despite underperforming the broader REIT market, office REITs are generating stronger returns than a year ago as sector fundamentals improve.

Year-to-date total returns for office REITS through Nov. 8 were 12.63 percent, according to data from the FTSE NAREIT U.S. Real Estate Index Series. During the same time period in 2011, office REITs provided investors with total returns of 1.90 percent.

Equity REITs had returned 16.53 percent in 2012 through Nov. 8.

Jason Lail, manager of the real estate research group at SNL Financial, said the sector currently has the lowest vacancy rate since the end of 2009. Vacancies ticked down in the third quarter of 2012 to 17.1 percent from 17.2 percent in the second quarter.

"Based on data from a Reis Inc. report, the rents also rose to $28.23 per square foot in the third quarter from $28.17 per square foot," Lail said. "Year over year, asking rents grew by 39 centers per square foot."

Jobs are expected to continue to play a large role in the performance of the office sector. The U.S. unemployment rate was 7.9 percent at the end of October.

"Slow labor market growth in 2012 has led to little new demand for office space, which inhibits office owners from enjoying higher rent levels and has somewhat counteracted the positive effect of minimal new supply coming online in 2012," Lail said.

Michael Knott, managing director with Green Street Advisors, said third quarter office earnings provided "mixed to disappointing news."

"Tenant uncertainty and a lack of confidence remain common refrains," he said.

Space usage is creating another headwind for the sector, according to analysts. Even if job growth does accelerate in the future, Lail said tenants looking to reduce their "space-per-employee exposure" could hinder demand.

While supply growth is limited overall, Knott pointed out that new construction is starting to emerge in certain markets, including in the San Francisco Bay Area. Office REITs currently have more than 4.5 million square feet in 21 new office assets under construction in the United States, Lail said.

"Two-thirds of those developments are expected to be completed by 2013 year-end," he said.