U.S. Office Vacancy Rates and Sublease Space Hit Record Highs in Q2 2023
The softening in key U.S. office market fundamentals, seen in the prior two quarters, continued in the second quarter of 2023. As a result, net absorption remained negative, while vacancy and sublease space hit new record highs.
The U.S. office vacancy rate stands at 16.4%, an increase of 30 basis points in the second quarter. Vacancy has inched above the prior peak of 16.3%, seen at the height of the Global Financial Crisis, with further upward pressure expected to follow.
On an encouraging note, net absorption, which measures the change in occupied office inventory, was positive in 37% of the metro office markets tracked in our national survey, up from 24% in the first quarter. National office net absorption totaled negative 14.4 million square feet, compared to negative 25.4 million square feet in Q1 2023.
Ten metro markets posted negative absorption above 500,000 square feet in Q2 2023, down from 17 markets in Q1 2023. Metro occupancy losses in the first quarter were led by the San Francisco Bay Area (negative 2.8 million square feet), New York City (negative 2.7 million square feet), and Atlanta (negative 1.7 million square feet). Washington D.C., Las Vegas, and Memphis led positive absorption.
There is a record 259.0 million square feet of sublease space available across the U.S. office market, up from 254.1 million square feet in Q1 2023, and considerably higher than the prior cycle’s peak of 143.3 million square feet seen in Q2 2009. 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. Construction activity continues to slow. Currently, 88.4 million square feet are underway, down 46% from this cycle’s peak of 164 million square feet in Q3 2020. The New York metro area has the largest amount of ongoing construction, at 12 million square feet, followed by the San Francisco Bay Area, with 8.1 million square feet, which is mostly focused on Silicon Valley, and Seattle, with 7.4 million square feet.
Asking rates are, by and large, showing little change. However, the gap between asking and effective rents remains significant, with generous concessions on offer. Tenant improvement allowances of $100 per square foot or more are available in most of the leading U.S. office markets when atenant signs a new 10-year lease on Class A space. In a similar manner, two-thirds of the leading markets are offering 10 months or more of rent abatement on such transactions. The return to the office remains gradual at best. Most firms are adopting hybrid working with a minimum of three days in the office per week emerging as the common standard. However, some employers are mandating a full-time return. Tenant downsizing has become the norm, with space reductions of at least 20% to 30% being implemented by large occupiers on new leases and renewals. While existing lease obligations will temper the pace of such changes, the net result should be sustained upward pressure on vacancy. Pending a resurgence in demand, vacancy rates and sublease availability are set to continue to rise over the rest of 2023, placing increased pressure on rents. As leases expire, the return of sublease space will also create a challenge for landlords in terms of both a drop in revenue and how to position and price such space. Class A downtown sublease space is being offered at a 30.5% rental discount to direct space across the leading markets.
With repricing taking place on the sales side, it seems imminent in the rental market driven by the triple-hit of downsizing, sublease space and rising vacancy rates, as landlords become increasingly aggressive to secure tenants. Performance and demand differentials are expected to widen. Bifurcation should be most evident between space class and age, but will also occur between and within markets, and different business sectors. Opportunities should become more selective, but quality will win out as firms seek the optimal work experience to retain and attract the best talent and bring employees back to the office.
Key Observations
- The U.S. office vacancy rate stands at 16.4%, up 30 basis points from the first quarter. Meanwhile, the total availability rate stands at 20.2% and has increased by 130 basis points year-over-year.
- Vacancy in this cycle has now exceeded the prior record peak of 16.3%, seen at the height of the Global Financial Crisis.
- Central business district (CBD) vacancy rates rose by 50 basis points in Q2 2023 to 17.3%, while suburban levels increased by 30 basis points to 16%.
- Jacksonville has the lowest metro vacancy rate outside of the tertiary markets at 10.1%, followed by South Florida (10.5%) and Las Vegas (11%).
- San Francisco has the highest metro vacancy rate at 25.71%, followed by Houston (22.1%), Indianapolis (21.1%) and Greater Los Angeles and St. Louis with both at 21%.
Asking Rents Show Little Change
- Average Class A full-service office asking rates increased by 1.2% over the 12 months ending Q2 2023 to $41.58 per square foot.
- Class A asking rates in CBD markets average $52.93 per square foot, up 0.4% over the past 12 months. Average Class A suburban asking rates stand at $34.56 per square foot, up 1.9% over the corresponding period.
- The gap between asking and effective rates remains significant. Tenant improvement allowances across the leading markets for Class A space average $117 per square foot, accompanied by an average of 11 months of rent abatement.
Absorption Remains Negative
- U.S. office absorption totaled negative 14.4 million square feet in Q2 2023, compared with negative 25.4 million square feet in Q1 2023.
- Net absorption was positive in 37% of the metro office markets tracked in our national survey, up from 24% in the first quarter.
- Occupancy gains in the second quarter were led by Washington D.C. at 1.2 million square feet, due to Amazon taking occupancy of two buildings at its HQ2 site. Las Vegas and Memphis also posted healthy gains of just over 300,000 square feet.
- On the downside, 10 metro markets had more than half a million square feet of negative absorption in Q2 2023, led by the San Francisco Bay Area (negative 2.8 million square feet), New York City (negative 2.7 million square feet), and Atlanta (negative 1.7 million square feet).
Supply-Side Risks Continue to Recede
- The amount of office space under construction in the U.S. stands at 88.4 million square feet, down 46% from this cycle’s peak of 162.6 million square feet in Q3 2020. The amount of space completed in Q2 2023 was 11.6 million square feet.
- CBD markets account for 45.7 million square feet underway, with 41.7 million square feet taking place in the suburbs. In addition, the pace of construction in CBD markets is greater, equating to 2.1% of inventory compared with 1% in the suburbs. The national level is 1.4%.
- The New York City metro has the greatest amount of construction underway at 12 million square feet, followed by the San Francisco Bay Area (8.1 million square feet) and Seattle (7.4 million square feet).
Sublease Space at an All-Time High
- Total sublease space available at a national level increased by five million square feet in the second quarter to 259 million square feet.
- San Francisco still has the highest sublease availability rate among the leading markets, by a fair margin, at 10%. Seattle is next, at 5.8%, followed by Silicon Valley at 5.6%. The average across the 15 leading markets is 4%.
- In an analysis of rental discounts for Class A sublease space over Class A direct space across the leading office markets, the average discount is 30.5%. Houston leads all markets with a 53.6% discount, followed by Chicago at 41.6%.
Investment Activity Muted as Repricing Occurs
- Total office sales volume in Q2 2023 was $12.5 billion, down by 58% year-over-year.
- Suburban properties continue to attract the most capital, with buyers placing $8.1 billion in such assets in Q2 2023 compared with $4.4 billion in CBD locations.
- Average pricing in Q2 2023 was $240 per square foot representing an 8% fall in values year-over-year. Pricing across the six major metros is down by 14% over the corresponding period.
- Average office cap rates stand at 6.9%, up by 70 basis points year-over-year, and are set to rise further.
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