Demand for office space across the country has dissolved in the years since the onset of the pandemic in 2020. Tenants have collectively handed back nearly 180 million square feet since the beginning of 2020; according to CoStar data; that is almost as much as Denver’s entire office inventory. Office attendance rates have fallen and plateaued at about half of what they were prior to the pandemic and companies have responded by closing offices, reducing their real estate use, and redesigning their remaining space to cater to a more flexible working environment. These decisions have been in part a result of economic concerns which are being fueled by softening consumer spending and persistent inflation that has been complicated by uncertainty over how quickly the Federal Reserve could begin lowering interest rates.

Low Office Leasing Volume

New U.S. office leasing volume totaled less than 100 million square feet in Q4 2023. This was the fifth consecutive quarter of leasing volume falling below a four-quarter rolling average in the past nine years, per CoStar data. For all of 2023, office leasing volume totaled an estimated 382 million square feet; that was only ~6% higher than 2020 and 14% below the average from 2015-2019. The total was also well below the 420 million square feet leased in 2022. Lower volume in 2023 was driven mostly by smaller leases. Since 2020, office users have given back over 180 million square feet; the negative absorption has surpassed the total amount of net move-outs that occurred during the great financial crisis. As the fourth anniversary of the COVID-19 outbreak nears, hybrid work persists, with 90% of companies offering a hybrid work arrangement in 2023, resulting in tenants shedding more unused space and revamping the offices they have retained. New leases are about 20% smaller compared to their pre-pandemic averages, a reduction that has not only pushed the national vacancy rate up to a record 13.6% but has also meant companies are figuring out how to do more with less real estate.

Sources: CoStar News

Winners Vs. Losers

Initial estimates of office transaction volume in 2023 suggest that a little more than $53 billion traded hands last year, a level reminiscent of 2010 in the immediate aftermath of the global financial crisis. The difference between those who made money or lost money on the sale of their office properties in 2023 mostly came down to when the property was acquired. CoStar reviewed sale comparables for the largest 100 individual office building sales in 2023 for which CoStar had a previous individual property price. Together, the 100 properties sold for $827.1 million less than their previous purchase price; half of the 100 sales showed losses. The net loss from the previous purchase prices averaged $42.63 per square foot, or 15%. The difference between who took gains and who took losses often was dependent on how soon after the Great Recession (Dec. 2007 – Jan. 2009) they had purchased the property; the earliest buyers typically came out on top. The 50 properties among the survey who had a higher sales price than their previous purchase price, the average gain was $150.44 per square foot. Of the 100 sales analyzed, buildings larger than 200,000 square feet collectively lost $990.2 million; everything smaller gained $163.1 million.

Sources: CoStar News

Office: Fort Collins / Loveland / Larimer County

Sources: CoStar

Office: Greeley / Weld County

Sources: CoStar

Uncertainty Threatens Broader Consequences

Some commercial real estate professionals say uncertainty surrounding the national office market is unlikely to fade in 2024 as they try to determine when demand will bottom. Emptied office buildings and smaller lease sizes may compound challenges for landlords, especially those facing maturing mortgage loans. 2024 kicked off with corporate job cuts, on-going inflation and indicators of slowed consumer spending, which has increased concerns surrounding the state of demand in the office market and its ability to drag on other parts of the economy.

Despite the uncertainly, the office market will eventually adapt as it moves through the subsequent stages of recovery and expansion. Many investors have stuck to the sidelines as office deals decline, however, some buyers are looking beyond the sinking valuations and rise in interest rates. Instead, they’re eyeing the chance to take advantage of the limited competition and secure deals they otherwise wouldn’t be able to entertain. The weakening market will create openings for investors ready and willing to open their wallets, particularly as lenders scramble to make up for widening losses and look to offload properties as quickly as possible.

Source: CoStar News

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