The office market, once a cornerstone of the commercial real estate industry, has been navigating a turbulent sea of change in recent years. As we step towards 23Q4, the market continues to face challenges that are reshaping its landscape. Office vacancy rates are climbing, leasing activity is down, and the very nature of office space is evolving. In this blog post, we’ll delve into the current state of the office market, analyzing key trends and projections for the future.
Rising Office Vacancy Rates
One of the most prominent trends in the office market in 2023 is the steady increase in vacancy rates. Nationally, office vacancy has reached a record 13.3%, the highest it has been in recent memory. Tenants have returned over 47 million square feet of office space since the beginning of the year, resulting in the lowest total occupancy since 17Q2.
Shrinking Space-Per-Worker Requirements
Despite office-using employment being nearly 12% higher, the amount of formally occupied but available-for-lease space has surged, standing more than 50 million square feet above historical norms. This shift highlights a significant change in workspace utilization, with today’s occupiers demanding approximately 440 million square feet less space than current employment levels would suggest. This trend has sent the ratio of occupied square footage per employed worker plummeting.
Declining Leasing Activity
The leasing data for 2023 reveals a concerning trend: the quarterly volume of new leasing activity is more than 15% below pre-pandemic norms. Moreover, the average size of new leases has shrunk by nearly 20%. This can be attributed to large tenants reducing their footprints upon lease renewal and smaller tenants choosing to relocate instead of renewing leases, skewing the composition of tenants in the market toward those with smaller space requirements.
Stagnation of Office Utilization
The sluggish recovery of office utilization is a central factor contributing to the market’s challenges. Various indicators, such as building occupancy, public transit ridership, and surveys, show that average office attendance has remained at 50-60% of 2019 levels for most of the past year. Even government agency offices were operating at only about 25% of capacity in 23Q1.
Economic Uncertainty
The office market’s woes are further compounded by the looming possibility of a recession in late 2023 or early 2024. While office-using employment is stable, the job market as a whole is showing signs of cooling, with job openings decreasing and the rate of voluntary quitting returning to historic norms.
Future Challenges
As we look ahead, approximately 55% of leases executed before 2020 have yet to expire, but about half of them are expected to do so by the end of 2025. This could lead to more negative absorption and higher vacancy rates in the coming months. Additionally, the delivery of an estimated 60 million square feet of new office inventory in 2023 will add to the supply side strain.
Office Pricing and Value
Uncertainty regarding future demand, coupled with higher interest rates, has put downward pressure on office pricing. On average, values have already dropped by about 10% from their peak in late 2021, with further declines expected. Forecasts anticipate a peak-to-trough value decline of 30-35% by mid-2026, signaling a challenging period ahead for the sector.
In conclusion, the office market in 2023 faces numerous challenges, from rising vacancy rates to shrinking space-per-worker requirements and declining leasing activity. The continued uncertainty surrounding office utilization and the broader economy casts a shadow over the market’s future. While there is resilience at the top end of the market, the overall outlook suggests that the office market may remain in a bearish state for the foreseeable future. It’s a transformative time for the office sector, and adaptation and innovation will be key for its survival and revival.
