Office has taken its licks during the pandemic, but that might be changing. The move toward stabilization in fundamentals is the overarching theme as fourth quarter begins, according to Colliers’ Stephen Newbold. GlobeSt.com reached out to the company’s director of National Office Research and Greg Inglin, Colliers’ EVP of the Puget Sound region, to discuss the current path of the office sector, its key indicators and one market surprise.
“We may be starting to turn the corner,” said Newbold. “The office sector witnessed a sharp correction over the past five quarters that marked the COVID-driven downturn, but the pace of decline slowed considerably in second quarter 2021. Two key indicators have grabbed the headlines: net absorption and sublease space.”
While the scale of quarterly occupancy losses should continue to lessen, further negative office market absorption during the remainder of 2021 is possible before turning positive in 2022. Although four quarters shorter, the COVID-19 downturn saw negative net absorption eclipse that of the Global Financial Crisis (GFC) by more than 60 million square feet (MSF) with a negative sum of 153.1 MSF over the past five quarters.
“Encouragingly, over a third of the 60 U.S. markets tracked by Colliers saw positive absorption in second quarter, led by Charlotte (525,480 SF), Nashville (382,750 SF) and Austin (343,950 Sf),” Newbold added.
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Although the rate at which sublease space is being added has been slowing for three consecutive quarters, the segment remains a key contributor to rising vacancy and pressure on rents. The record 208.6 MSF of sublease space available nationally significantly overshadows the prior peak of 143.3 MSF seen in second quarter 2009.
Newbold noted the market variation of this key inhibiting factor, with San Francisco “bearing the brunt” at 8.5 MSF of sublease space, equivalent to 8.8% of market inventory and double the next highest top 10 market (Seattle’s 4.3%). Conversely, sublease availability in the District of Columbia and Atlanta are only 2.1% and 2.4%, respectively.
“Class A CBD sublease space across the top 10 office markets is being offered at a 26.7% discount to comparable direct space,” said Inglin. “The subleases are transacting because the value proposition of lower rent and flexibility.”
Renewals are also helping boost leasing activity. Landlords are obviously doing more to keep tenants, but also the cost of tenant improvements for new leases has increased significantly, adding to the cost of relocation.
“Renewal can be the ‘easy button’ for tenants,” Inglin added. “The story of 2021 and early 2022 will be the return to lease transactions, primarily on subleases and renewals. Look for an increase in ‘blend and extend’ renewals as landlords seek to retain tenants and lengthen lease commitments.”
COVID-19’s impact on the office sector has been drastic, the softening in market fundamentals has yet to result in any appreciable reduction in asking rates, according to Newbold. By comparison, Class A CBD asking rates fell by 25%, coupled with a 10% decline in the suburbs during the GFC.
“While the gap between asking and effective rents continues to widen, the market is relatively untested due the lower volume of leasing activity,” he added. “As more tenants return to the market, competition between landlords to capture them, coupled with high-quality, discounted sublease options, could drive a fall in rents at a time when other office fundamentals have stabilized.”