U.S. Office Market Report | Q3 2023

In 12 markets, negative absorption exceeded 500,000 square feet in Q3 2023, up from 10 in the previous quarter. For the second consecutive quarter, San Francisco led in metro market occupancy losses, reporting a negative 3.8 million square feet in the third quarter. Additionally, Atlanta, Greater Los Angeles, Greater New York City, Phoenix, and Minneapolis-St. Paul each posted over one million square feet of negative absorption during the same period.

During the height of the Global Financial Crisis, available sublease space peaked at 143.3 million square feet. In Q2 2023, the U.S. office market recorded a new high of 259.2 million square feet of sublease space. However, in perhaps a positive sign of things to come, the market retreated from its peak by shedding just over two million square feet of sublease space during the third quarter. As firms continue to evaluate their post-Covid real estate needs, sublease space will remain a cost-competitive, short-term option until there is greater clarity on economic and business direction.

Despite a vacancy rate surge of 530 basis points since the start of the pandemic, overall asking rents have been minimally impacted, as most landlords have held firm and more expensive new construction is delivered. Effective rents, which consider landlord concessions, have behaved more in line with softening market fundamentals. Approximately two-thirds of the leading markets are offering 10 months or more of rent abatement when a tenant signs a new 10-year lease on Class A space. Additionally, tenant improvement allowances of $100 per square foot or more are available for similar lease terms in most of the leading markets.

According to Kastle Systems’ 10-City Back to Work Barometer for the week ending October 4, 2023, office occupancy surpassed the halfway mark, rising to 50.1%. However, Kastle’s return to office metric has remained relatively stagnant over the last year, increasing by 110 basis points in occupancy. While some employers have mandated full-time returns, firms enforcing those policies remain few and between. Most firms are adopting hybrid working with a minimum of three days in the office per week. Kastle data for September 2023 indicates that the highest-average-attended day was Tuesday at 59.2%, with the lowest on Fridays at 32.5%. While their data shows that midweek occupancy has grown over the last year, Friday attendance has declined during that time.

A continued rise in vacancy rates is expected for the foreseeable future as new product is delivered and tenant downsizing becomes more entrenched in new leases and renewals. While existing lease obligations will temper the pace of such changes, the net result should be sustained pressure on vacancy rates and rents.

The abundance of sublease space will add to this pressure, posing significant challenges for landlords when leases expire. Some landlords may face difficulties financing necessary improvements on returned space due to tightening credit conditions and higher interest rates. Making no improvements will remain an option; however, given that the average Class A CBD sublease space is offered at a 30.5% discount to direct space across leading markets, offering these spaces at such a reduced rate could negatively impact the assets’ overall value.

Repricing in the sales sector is expected to spill over to leasing in 2024. Landlords who acquired significantly discounted properties will operate on a lower cost basis, allowing them to be more competitive with rents and attract tenants to non-trophy assets.

Anticipated variations in performance and demand will become more evident, particularly among different classes and ages of office spaces. Differences will also emerge within and across various markets and business sectors. Opportunities will become more selective, with a focus on quality, as businesses strive to optimize the workplace experience to retain and attract top talent and encourage employees to return to the office.