Yet another gloomy assessment of the state of the U.S. office property market has emerged, this time from Newmark. Even some once-hopeful signs of life in certain sectors now seem less hopeful, while overall leasing activity continues to slow and access to capital remains hard to come by.
The ray of light in the gloom has been the "office-using sector", especially technology, advertising, media and information companies, which Newmark says drove much of the leasing activity over the past two years. National office-using employment is currently 6.3% above December 2019 figures, and continues to expand. "However, in the year-to-date, technology companies have accounted for just 8.7% of leasing activity, down from 37% in 2022," Newmark reported.
Another segment of the office market that has been performing relatively well is Class A assets. "While Class A leasing activity as a percentage of inventory is pointing downward in the second quarter of 2023, it still exceeds the national average by 20 basis points," Newmark noted. However, it cautioned, that is below the 40 basis points average achieved during the previous 12 months. "The Class A advantage appears to be eroding on the margins," Newmark commented.
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The broader office market experienced a continuing contraction of net absorption in 2Q 2023, resulting in space givebacks totaling negative 17.5 million SF. The West and East were worst affected. Occupancy was lower in both gateway and secondary markets, affecting even the more buoyant South and Sunbelt regions. Indeed, occupied space contracted in 41 out of 56 markets in 2Q 2023. Leasing activity was sluggish across the board, slipping to 0.8% of inventory.
Investment in offices has also plummeted. It fell 65% year over year in 1H 2023. Despite a slight 4.8% uptick from the first quarter, office loan originations declined 60% year over year in the second quarter. Total originations to date in 2023 are 55.4% compared to 1H 2022, Newmark reported, citing RCA data that shows office origination volumes in 1H 2023 were the lowest since 2011. "Office sales declined in the first half of 2023 across every major dimension: region, market tier, subtype, risk profile and class," it added.
Ominously, but in line with other predictions, Newmark foresees trouble ahead for investors seeking new money. "Nearly $400 billion in office loans mature between 2023 and 2025. Of these, we estimate $351 billion would have an LTV [loan to value] of 80% or greater if marked to market. They will struggle to refinance existing loans, and legacy debt issues will impede new financing in the sector," the company stated.
The increase in the cost of debt has spilled over to affect transaction cap rates. They rose by 80 basis points quarter over quarter in 2Q 2023, "after months of puzzling stability in the face of rising rates and uncertainty," with more increases expected. CBD cap rate levels for office markets are converging with suburban levels, while yields in major metros now appear higher than in non-major metros.
'Office REITs are trading an implied 9.7% cap rate and are the only office sector offering above-average spreads to the cost of debt," the report noted.
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