Market Observations
- Labor Markets: National office-using employment is now 6.0% above January 2020 levels, with the recovery being led by technology, advertising, media and information companies. These new jobs equate to an estimated 236.5 million SF of office demand, helping to soften the blow the hybrid work office demand shock. However, office-using job growth is now slowing. Indeed, office-using employment contracted in 31 of the top 50 office markets in the last 6 months.
- Hybrid Work Transition: Slowing job growth leaves markets more exposed to the ongoing demand adjustment to hybrid work. Newmark estimates that 57% of pre-pandemic leases have yet to come up for renewal, including 1.9 billion SF of renewals in the 2024-2027 period. Average lease size has declined by 13.6% compared to pre-pandemic suggesting further reductions in overall office demand.
- National Trends: Leasing activity remained sluggish in most markets in the first quarter of 2024, decelerating nationally to an estimated 0.8% of inventory, compared with the quarterly average of 1.4% realized between 2012 and 2019. Net absorption continued to post losses in 1Q24, but more notably, net absorption decelerated quarter over quarter to -15.5 million SF, breaking its recent upward trend. Negative net absorption was broad-based with occupied space contracting in 40 out of 58 markets tracked by Newmark. National vacancy rose 40 bps to 20.1%. More positively, office inventory under construction declined to 48.2 million SF, a trend expected to continue.
- Regional Trends: All regions posted occupancy declines in the first quarter of 2024, led by the East region where occupancy declined by negative 7.6 million SF. Minimal leasing activity as a percent of inventory was relatively ubiquitous across most regions, indicating a slowdown in the momentum that had been gained in the prior two years in some secondary and Sun Belt markets.
- Market Size Trends: Gateway markets shed most space in the first quarter of 2024, led by New York, Boston and Chicago. Tertiary markets recorded relatively flat occupancy growth and have continuously outperformed since 1Q21 albeit representing a small share of the national market.
- Rent Trends: Asking rents increased 1.1% year over year in 1Q24, led by Tertiary markets in apparent defiance of the law of supply and demand. Concessions packages remain significantly higher than they were pre-pandemic pushing down effective rents. TI allowances are 70% higher than they were pre-pandemic on average based on an analysis of leading office markets.
- Class Conundrum: Class performance is more nuanced than the dominant flight to quality narrative suggests. The lowest availability rates are in post-2019 delivered buildings and Class B offices nationally, particularly in suburban markets. The highest rates are in commodity Class A buildings. Asking rent growth is somewhat disconnected from availability rates. Commodity Class A rents have grown 5.2% since 4Q19 in suburban markets, despite having the highest availability for example. Combining metrics as rent per available foot, it becomes clear that legacy trophy assets, commodity Class A and Class B buildings have also suffered reductions in cash flow potential, but commodity Class A has underperformed. There seems to be a free lunch to the owners where they to reduce rents and attract occupiers from Class B buildings. Why has this not happened, and why has there not been a broader adjustment in rents more generally given ongoing high availability? One possibility is that undercapitalized owners face strong incentives to resist adjusting rents, particularly where large incentive packages result in negative cash flows early in a lease.
