Introduction
The U.S. office market has undergone a turbulent journey since the pandemic began, and it seems like 2024 will be another challenging year. However, there is hope that this year will bring the sector closer to a post-pandemic normalcy, according to the latest U.S. office market report.
Trends & Industry News: Another Precarious Year for Office
In 2024, office utilization rates are expected to gradually increase, even though a full-scale return to the office is unlikely. Many large firms, such as Amazon, Meta, and Zoom, have implemented return-to-office mandates. However, even among these companies, hybrid work schedules and reduced office footprints are being embraced. Most companies are settling for two to three days of in-person work per week. The physical occupancy rates are not expected to rise significantly compared to last year. The rise of hybrid and remote work is also expected to decrease the prevalence of long-term fixed leases, with tenants prioritizing flexibility.
"In 2024, we expect an acceleration of less desirable office buildings being removed from the marketplace," says Peter Kolaczynski, Director at CommercialEdge.
Foreclosures on office buildings are anticipated to increase at varying rates in different markets, submarkets, and property qualities. Loan extensions, workouts, defaults, and foreclosures are expected to become more common this year. The level of distress and delinquencies will be greatly influenced by the direction of interest rates.
While interest rates remain uncertain in the commercial real estate industry, it appears that increases are unlikely for the time being. This year is expected to see a rise in transactions as expectations align and the bid-ask gap narrows due to a stabilized cost of capital. However, the average sale price of office properties is anticipated to decrease for the third consecutive year. While office investors need to be prepared for risk, there will be attractive opportunities available at discounted prices.
Office conversions are expected to continue at a steady pace, similar to the levels seen in 2023. Converting vacant office buildings into residential spaces has been a popular solution to the problems caused by the pandemic. However, there are still many challenges and roadblocks to overcome in this process.
Caption: In 2024, the office sector faces challenges in terms of occupancy rates, lease flexibility, and distressed properties.
Listing Rates and Vacancy: Office Occupancy Rates and Rents Continue to Decline
According to the U.S. office market report, the national average full-service equivalent listing rate was $37.64 per square foot in December, representing a 1.4% decrease year-over-year. Listing rates for A and A+ office spaces averaged $46.10 per square foot, down 1.3% from the previous year. Meanwhile, Class B office rates increased by 20 basis points to $30.30 per square foot, and Class C rates increased by 90 basis points to $22.95 per square foot year-over-year in December.
In terms of location, suburban assets were the only ones to experience growth, with listings rates rising by 80 basis points to $30.60 per square foot year-over-year. On the other hand, listing rates for CBD and urban offices fell by 6.2% and 1% year-over-year, respectively, to $48.40 per square foot and $43.99 per square foot.
The U.S. office vacancy rate increased by 180 basis points year-over-year to 18.3% in December. CBDs had the highest vacancy rates, with empty spaces accounting for 18.5% of stock. Urban and suburban office assets had vacancy rates just below the national average at 17.9% and 18.2%, respectively.
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Caption: In December, the U.S. office market had an 18.3% vacancy rate, with suburban assets showing the most growth.
Supply: Construction Starts Fall 35% in 2023 Compared to Previous Year
As of December, there were 96.9 million square feet of office space under construction nationwide, accounting for 1.4% of existing stock. In 2023, the total office space that broke ground was 40.6 million square feet, a 35% decrease from the previous year. This decline is even more significant when compared to pre-pandemic years, with construction starting on 80.8 million square feet in 2018 and 98.5 million square feet in 2019.
The office real estate outlook predicts that construction starts will continue to decrease in 2024 as construction loans become harder to obtain and office vacancy rates continue to rise.
Caption: In 2023, construction starts for office buildings fell by 35% compared to the previous year.
Transactions: Class A and B Asset Spread Narrows
The U.S. office market recorded $33.8 billion in office sales in 2023, with an average price of $196 per square foot. This is a significant decrease from the $83.6 billion in office deals recorded in 2022, with an average price of $280 per square foot.
The average sale price of Class A+ or A buildings fell by 21.1% year-over-year to $390 per square foot in 2023. Class B properties saw a smaller decline of 8.5%, with an average price of $278 per square foot. The spread between the average sale price of Class A+/A properties and Class B properties was one of the smallest ever recorded.
Caption: The U.S. office market saw a decrease in sales volume and average sale price in 2023.
Western Markets: Vacancy Rates Continue to Climb in the Region
Leading office markets in the Western U.S. ended 2023 with some of the highest vacancy rates in the country, consistent with trends throughout the year. San Francisco had a vacancy rate of 23.6%, ranking third in the nation behind Detroit (25%) and Houston (24%). Seattle and Denver followed with vacancy rates of 22.5% and 22.2%, respectively.
Vacancy rates are projected to increase in 2024 as leases expire, particularly in San Francisco. KPMG, the accounting firm, might exit its tower at 55 2nd St. in San Francisco after a two-decade occupancy due to the expiration of its lease at the end of 2024. As office occupancy rates decline, landlords are offering concessions to attract tenants. Asking rents in San Francisco decreased by 7.8% year-over-year in December, reaching $61.91 per square foot.
Caption: San Francisco, with a 23.6% vacancy rate, is among the office markets with the highest vacancies in the country.
Midwestern Markets: Chicago Records Just Over $1 Billion in Sales in 2023
Chicago led the Midwest in office sales in 2023, with closed deals totaling $1.14 billion. However, it had the lowest average sale price nationwide at just $100 per square foot. This marked a substantial decline from the $3.32 billion in sales and the $186 average price per square foot recorded in 2022.
Detroit had the lowest sales volume among Midwestern markets, with total sales amounting to just $342 million. Despite having a price per square foot slightly above Chicago's, Detroit's market struggled. On the other hand, the Twin Cities recorded the highest sales price in the region at $190 per square foot, but the overall sales volume was only $499 million.
Caption: Chicago recorded the largest sales volume in the Midwest in 2023, despite having the lowest average sale price.
Southern Markets: Dallas-Fort Worth Sees Occupancy Rates Slip
Miami remained the most expensive office market in the South, with an average listing rate of $46.76 per square foot. Austin and Washington, D.C., followed closely with asking rents of $41.20 per square foot and $40.62 per square foot, respectively. Orlando and Dallas had the lowest rates in the region, with listings at $23.95 per square foot and $26.99 per square foot.
Dallas-Fort Worth experienced robust job growth in the office sector but saw its vacancy rate increase by 170 basis points to 20.2% year-over-year in December. Despite the high vacancy rate, the market had the second-largest construction pipeline in terms of square footage, with over 4.8 million square feet underway.
Caption: Dallas-Fort Worth, despite its high vacancy rate, has the second-largest construction pipeline in the U.S.
Northeastern Markets: Manhattan Leads in Sales, Despite Volume Decline
Manhattan had the highest sales volume in the U.S., with closed office deals amounting to $2.69 billion in 2023. Manhattan also had the highest sale price per square foot among the top 25 U.S. markets, at $783. However, the sales volume in 2023 was a significant decline from the previous year's total of $6 billion.
Boston had the second-largest sales volume in the Northeast, with closed deals totaling $1.55 billion at an average price of $300 per square foot. New Jersey had a sales volume of $1.24 billion, while Philadelphia's sales volume reached $542 million.
Caption: Manhattan leads the U.S. in sales volume, with closed office deals totaling $2.69 billion in 2023.
Office-Using Employment: Mixed Growth Across Markets
In December, the office-using sectors of the job market added 29,000 jobs. However, on a year-over-year basis, the growth in office employment was only 0.3%. Among the 120 markets covered by CommercialEdge, 56 experienced a year-over-year decline in office employment.
The office job market's growth has been more pronounced in the Southeast and Texas, while the Northeast, Midwest, and California have seen a deceleration in growth. Miami, Dallas, Austin, Houston, and Nashville are leading in job gains, while the Bay Area, Twin Cities, Los Angeles, Chicago, and San Diego have experienced significant drops.
Caption: The office job market has seen mixed growth across different regions in the U.S.
Conclusion
The U.S. office market faced significant challenges in 2023, with sales volume and average prices decreasing compared to the previous year. The market continues to grapple with high vacancy rates and a decrease in office utilization due to hybrid work schedules. However, there are opportunities for investors willing to take on risk in this evolving landscape. As the industry adjusts to post-pandemic norms, the office market may find stability and new possibilities for growth.
Note: This article is based on the latest U.S. office market report and provides an overview of key trends and insights in the industry. For a more detailed analysis, including regional breakdowns and market maps, please refer to the full report.
