As the pool of available sublease space expands and demand has started to weaken again, net absorption has fallen back into negative territory. Uncertainty regarding everything from remote work policies to high inflation and an increasingly aggressive Fed suggests that the office market’s recovery is still some distance in the future. Sublease availability sits at a record high of 214 million SF, and of the just over 140 million SF currently under construction, 35% remains available to lease. Nevertheless, a notable drop in new starts should help balance things out a bit in coming years. Overall, transaction activity totaled around $107 billion in 2021, returning to pre-crisis norms, although the new higher interest rates implemented by the Fed could slow this growth in 2022.
Q2 US Office Report
Leasing activity is the best sign that at least some companies are returning to the office. While it remains below pre-pandemic levels, leasing activity has exceeded 100 million SF for 3 consecutive quarters. Unfortunately, sublease availability is also reaching new highs for a total of 214 million SF. Also troubling is that 46% of the sublease space listed as available is currently occupied, which suggests that rent is still being paid there but it’s likely to be vacated at the end of the current lease term. Sun Belt markets like Austin, Nashville, and Miami continue to lead the list of top markets.
Rent growth has continued to move in a positive direction, but it’s slow, so many landlords are still offering generous incentive packages. In addition, a growing number of sublease listings is putting pressure on an already flooded market. While the pandemic impacted all building quality cohorts, 4 and 5-star properties are recovering more slowly. The Sun Belt markets of Miami, Orlando, Las Vegas, and Phoenix are currently seeing the best growth, while San Francisco, New York, and DC remain year-over-year losers.
Although development has slowed from its pre-pandemic levels, the amount of speculative office space underway remains high. Of the current 141 million SF in the current pipeline, 35% is unleased, and of the space that has been delivered since 2020, 25% remains unleased. Thus, even if leasing volume improves, new deliveries will continue to put pressure on the vacancy rate for at least the next few quarters. Major tech center markets, like San Jose, Austin, and Seattle, as well as the life science hubs of Boston and San Diego remain strong. These are joined by Sun Belt Metros that have maintained growth through the pandemic, including Nashville, Miami, and Charlotte. While perennial construction leaders like New York, DC, and LA continue to have more development than most metro areas, their growth has cooled considerably as their office markets struggle to recover.
The top cities for office property sales at the beginning of 2022 include New York, LA, Dallas, Boston, and Houston, showing some growth even in high-ticket markets that are otherwise struggling to recover. Investors do seem to be gaining confidence despite near-term uncertainty. Indeed, for the year, investment returned to pre-pandemic levels, totaling approximately $107 billion, and more than $27 million in assets trading occurred in Q1 2022. In addition, the share of distressed sales remains low, and the current inflationary environment favors commercial real estate investment, where cash flows can adjust more readily than in fixed income assets.
As one crisis follows another, the economy has proved both difficult to predict and to manage. Just as pandemic recovery became visible on the horizon, Russia’s war against Ukraine disrupted markets for everything from energy to wheat. As a result, Q2 2022 closed with a 1.4% annualized decline, the first since the 31.2% fall out of Q2 2020 that was a response to the pandemic.
As shortages and other supply chain issues continue to plague many industries, inflation is also rising, although the rate of that increase may have finally plateaued, closing out the quarter at 6.2% after reaching a 4-decade high of 8.5% in March. In addition, after being supported by stimulus payments during the early days of the pandemic, consumer spending has started to slow, and the shift from durable goods to services that marked the latter part of 2021 and beginning of 2022 started to roll back in April, potentially as a response to inflation, shrinking household savings, and outbreaks of new Covid variants.
Finally, the labor market remains tight, with the unemployment rate at 3.6%, just slightly more than its pre-pandemic level, and labor participation remaining below pre-pandemic levels, as lack of childcare and protection from Covid continue to keep people at home. Nevertheless, an average of 560k jobs were added per month in 2021, and more than 2.4 million have been added in the first half of 2022. With almost 2 job vacancies for every unemployed worker, competition for employees is fierce, driving up wages and increasing incentives. All of this puts the Federal Reserve in the difficult position of trying to slow economic growth while also addressing the continued supply shock.
This is a summarized version of an office market report that was originally created by CoStar. The full report can be found here https://www.compass-commercial.com/office-usa-market-report/