Inconsistent office usage impairs demand
The U.S. office sector enters the second half of 2022 in precarious conditions. Offices across the country remain sparsely utilized despite a nearly full recovery in air travel, hotel bookings and restaurant dining. The adoption of hybrid work has drawn daytime activity out of central business districts, creating a void that’s been exacerbated by a rise in crime in many cities.
Employees in most industry segments are gradually returning to offices, yet inconsistently, with the majority of employers embracing flexible and hybrid work schedules, deferring to employees who still have the upper hand. Based on Avison Young’s proprietary “AVANT Vitality Index” analysis of weekly mobility data, 41.9% of weekday foot traffic has returned to office buildings across the U.S. relative to the week preceding the pandemic, up from 27.7% one year ago. That said, the index demonstrates a substantial gap between cities like New York driven by banking and finance leading at 53.4% and markets like Silicon Valley driven by big tech substantially lagging at 36.8%.
With office usage well below pre-pandemic rates, it’s no surprise that leasing activity remains subdued, causing vacancy to rise further. Investors are assessing opportunities to reinvent the abandoned office towers least likely to recover from an enduring shift to working from home.
Office Vitality Index
90.4 sf
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Under construction inventory
Development pipelines in most major markets are emptying and potential conversions of Class B and Class C properties should help to rebalance supply gluts and weaker demand. However, developers encouraged by the flight to quality seen in post-pandemic leasing are still initiating some spec developments in secondary and tertiary tech markets including Austin, San Jose, Seattle, and Raleigh.
0.1%
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Net absorption
Tenant occupancy loss in older second-generation space accelerated, driving total net absorption into negative territory. New vacant sublease listings outweighed completed sublease deals. However, occupancy gains in new inventory boosted direct net absorption into positive territory.
16.0%
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Vacancy
Vacancy continues to rise into uncharted territory and will likely remain on an upward trajectory in the near term until leasing activity picks up. Trophy building vacancy in Tier 1 markets—Manhattan, Washington, DC, Los Angeles, Chicago, and San Francisco—remains relatively compressed, averaging 10.8% in Q2 as tenants exhibit a flight to quality.
20.7%
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Availability
Sublease availability returned to an upward trajectory after subsiding in the final half of 2021 and reached a new high-water mark at over 170 MSF or 3.3% of inventory. New sublease listings are hitting the market as businesses embrace remote work strategies and reduce lease commitments amid weaker economic conditions.
$34.56 psf
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Asking rate
Asking rents are up 2.0% over the past year as new developments command a premium. Trophy buildings lead the gains, with rents up 3.0% as tenants concentrate in top quality space in efforts to encourage workforce returns.
$79.83 psf
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Concessions (TI allowance)
Landlords are maintaining face rents but providing substantial concessions to offset escalating build-out costs. For example, average concession packages on 10-year deals in Manhattan include $99.47 psf in TI allowance and 10.6 months of free rent, up from $83.18 psf and 6.9 months in the beginning of 2020.
$395 psf
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Average sale price
Pricing power endures as cap rates remain compressed, but sale volume declined in the first two quarters of 2022, reversing course from what had been a strong and consistent rebound from immediate post-COVID lows. The cost of capital is rising and risks to operating returns remain elevated, which may have pushed some players to the sidelines. Furthermore, commercial real estate capital flow has shifted away from the deteriorating office sector, from over 25.0% of sales volume in each quarter preceding the pandemic to 19.5% of the mid-year 2022 total.
