The U.S. office market started 2024 right where last year ended, as demand remained low.
Key Takeaways:
- Demand remains low, with most new leases involving reductions in space rather than expansions.
- New construction starts have paused as developers take a “wait and see” approach to any increase in activity while construction and financing costs remain high.
- The trophy market has seen the most activity, and the well-located, amenity-rich locations remain attractive.
The U.S. office market started 2024 right where last year ended, as demand remained low. An influx of surplus space returned to the market, notably increasing the overall vacancy rate. Economic uncertainty continued to drive tenant decision-making, leading many with near-term lease expirations to sign short-term renewals. With additional time for economic recovery, this strategy may offer a better understanding of the direction a company may want to take with its real estate, especially with a presidential election looming later this year.
Tenants continued to be attracted to top tier properties in well-located, amenity-rich locations. While not a new trend, the concentration of activity in these trophy assets is notable in today’s environment as it gives insight into the wants and needs of tenants in the market. These are usually newer buildings with lots of natural light, flexible floor plan options, and proximity to amenity and transportation nodes. These features attract tenants looking for more flexibility as they reimagine the workplace post-COVID.
New development starts have hit a pause throughout the country, as development costs and interest rates remain elevated. With 63.9 million square feet under construction and 20 million square feet returned to the market in existing stock, most developers are sitting on the sidelines to wait until demand picks up to put shovels in the ground on new sites.
The U.S. office vacancy rate rose to 17.5% at the end of the first quarter of 2024, a post-COVID high. That was the second consecutive quarter of vacancy at more than 17.0%, and a 40-basis-point increase from that at the end of 2023. One year ago, the vacancy rate was 16.2%. The Class A vacancy rate was 20.4%, up 130 basis points over the past year.
More than 20 million square feet was returned to the market in the first quarter, relatively evenly split between Class A and B. However, net absorption for the quarter was not as low as that in the first quarter of 2023. The majority of new leases signed represented reductions in space, as tenants continue to embrace different workplace occupancy models than when their previous leases were signed.
The U.S. average asking rent across all classes was $36.94/SF FSG at the end of the first quarter, up 0.3% from last quarter and 2.5% from one year ago. The delivery of 11.7 million square feet of new higher-cost space, the majority not preleased, is a significant component of rising rents. The Class A asking rent was $42.39/SF, up 0.1% from last quarter and this was the lowest quarterly increase in 18 months. The Class B average asking rent was $30.26/SF, up 0.1% over last quarter and up 3.5% from one year ago.
The Mortgage Bankers Association estimates that $385 billion of office debt will mature through 2026. To refinance this debt, loan paydowns will be required. Distress is already emerging, and more is to come. This has the potential to reset the cost basis for new owners, allowing them to undercut the market with lower rents.
The economy remains resilient, with strong job growth, low unemployment, and healthy consumer spending. Inflation has fallen and held steady after actions by the Federal Reserve in 2023. Interest rate cuts were expected in 2024 but will likely be pushed back a few months until inflation falls further. The unemployment rate in March 2024 was 3.8%, 10 basis points below February’s rate but up 30 basis points from March 2023.
Overall, the U.S. added 303,000 in March 2024, 1.9% higher year-over-year. The private education and health services sector had the highest job growth of a 4.3% jump from March 2023 to March 2024. Two of the three office-using sectors, financial services and professional and business services, had year-over-year growth in employment. Jobs in the information sector, however, declined by 1.2%, the largest annual decrease for all sectors in the U.S. Year-over-year, Las Vegas, Miami, Sacramento, Austin, and Raleigh had the highest metro area job growth in the first quarter.
Vacancy
- The divide between CBD and Suburban markets was 150 basis points, with the CBD vacancy rate at 18.5%and the suburbs at 17.0% across all classes. In each subsector, vacancy increased by 30 basis points from last quarter.
- The Northeast region, the largest with 1.9 billion square feet of office space, had the lowest vacancy rate at the end of the first quarter, 16.4% across all classes.
- Of the 58 metro areas tracked, 23 had vacancy declines from the last quarter. Savannah, GA and Charleston, SC, had the largest declines, as both rates fell more than 150 basis points. Columbia, SC and Cleveland, OH, had declines of 130 basis points and 120 basis points, respectively.
Net Absorption
- U.S. net absorption was negative for the sixth consecutive quarter. More than 107 MSF was returned to the market over this time, or 1.7% of the total U.S. inventory.
- The first quarter of 2024 net absorption of negative 20.4 million square feet was dominated by the West and Northeast, which accounted for 44.2% and 32.3%, respectively.
- Austin and Nashville each had more than 200,000 SF absorbed, the highest net absorption for the quarter.
Construction Activity
- The amount of U.S. space under construction reached its lowest total post-COVID, dropping to just under 64 MSF. Once completed, that will increase inventory by 1.0%
- The New York City metro leads all metro areas with 6.9 MSF under construction.
- Manhattan delivered 4.0 MSF in the first quarter, 34.5%of the 11.7 MSF completed nationwide.
- The decline in new construction starts will help improve the imbalance between supply and demand.
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