USA National Office Market Report as of October 1, 2023

[Manuel Angeles]

Greetings,

Here is an update on the current National Commercial Office Real Estate Market in The United States of America:

Office vacancy has continued its climb so far in 2023, reaching a record 13.4% nationally, with tenants collectively giving back over 47 million square feet since the beginning of the year. Total occupancy is now at its lowest level since 17Q2, despite office-using employment being nearly 12% higher. On top of this, the quantity of space that is formally occupied but nevertheless available for lease is more than 50 million square feet above its historical norm, having risen steadily since mid-2020.

Thus, in the aggregate, today's occupiers demand about 440 million square feet less than current employment levels suggest – an amount larger than the entire inventory of Los Angeles, the nation's fourth-largest office market. This has sent the ratio of occupied square footage per employed worker plummeting to 8% below what it was entering 2020, accelerating a decade-long trend of shrinking space-per-worker requirements.

Recent market and secular trends suggest that stagnant demand is likely to linger and that space-per-worker requirements could shrink even further. Leasing data for 2023 to date shows the quarterly volume of new leasing activity to be more than15% below pre-pandemic norms; moreover, the average size of a new lease has shrunk by nearly 20%. This is consistent with two trends noted by market participants. One is that large tenants are reducing their footprints when existing leases roll over. Another is that smaller tenants are choosing to relocate rather than to renew, thus skewing the composition of tenants in the market toward those with smaller requirements.

The secular explanation for this is the stagnation of office utilization, which is enabling employers to support more workers with less space. Various return-to-office indicators such as the Kastle Systems building occupancy index, public transit ridership data, and largescale employee/employer surveys, show that average office attendance nationwide has held steady at 50-60% of 2019 levels (though somewhat higher on midweek peak days) for the better part of the past 12 months. One recent addition to this body of evidence is a July Government Accountability Office report showing that federal government agency offices were typically operating at about 25% of capacity in 23Q1.

The slow recovery of utilization comes against the backdrop of a surprisingly resilient labor market. Layoffs in office-using industries were elevated from 22Q4 through the early portion of 23Q2, but have since normalized. And while organizations in the tech-heavy information sector have not added any net new jobs since May of 2022, they are still employing about 8% more workers than they were at the beginning of 2020.

Overall, office-using employment is right where long-term trends suggest it should be. However, there are headwinds blowing. The majority opinion among economists is that a long-expected recession will materialize in late 2023 or early 2024. With job openings pulling back from record highs and the rate of voluntary quitting back down to historic norms, economic uncertainty already appears to be cooling the knowledge labor market.

This scenario suggests a long road to recovery for the sector. An estimated 55% of leases executed prior to 2020 have yet to face an expiration, but about half of these are expected to do so by the end of 2025. This is likely to lead to further negative absorption and higher vacancy in the coming months. An estimated 60 million square feet of new inventory is set to deliver during 2023. This will add a temporary strain from the supply side as well, though deliveries should slacken in the years ahead.

The uncertainty of future demand has exacerbated the downward pressure on office pricing wrought by higher interest rates. On average, values are down about 10% from their peak at the end of 2021, and this appears to be only the beginning. CoStar's house view forecast anticipates a peak-to-trough value decline of 30-35% by the middle of 2026, comparable to what happened after the Great Recession and far steeper and longer than the double-digit corrections expected in other commercial property sectors.

There is resiliency at the top of the market, including 5- Star and new-vintage buildings, where rent growth has remained positive. But overall, outside a few Sun Belt geographies like Miami and Las Vegas, the office market looks to be a bear market for some time to come.

Here are several graphs illustrating the current national commercial office market in The United States of America:

Here is the full USA office market report for you to review: https://d2saw6je89goi1.cloudfront.net/uploads/digital_asset/file/1170834/United_States-Office-National-2023-10-02_compressed.pdf

Data includes: Sale price per unit distribution, cap rate distribution, cumulative sales volume by year, months to sale, recent significant sales, vacancy rates, market rent per square foot, construction deliveries/demolitions, economy, job growth. population growth, and Los Angeles county sub-market activity.