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Since the coronavirus pandemic began, the American office market has faced unprecedented challenges. Government lockdown mandates prompted millions of businesses and institutions to operate remotely or with limited onsite staff. However, temporary emergency measures eventually evolved into a paradigm shift.
Multinational corporations and small companies enjoyed significantly lower overhead costs, and workers appreciated the greater sense of work-life satisfaction that came with not needing to commute five days a week. As a result, calls to return to the office have been met with heavy resistance in specific industries, leading to high-profile defaults and evictions in some major urban markets.
Consequently, CBRE reported the national office vacancy rate reached 17.8% in the first quarter, its highest level in 30 years.
Here’s an examination of why so many gleaming office towers are still underpopulated or empty and the three reasons to be hopeful about the sector’s future.
Tech Sector ‘Reckoning’ Continues Affecting CRE
The biggest issue affecting office markets in California and Colorado is volatility in the technology sector.
Last year, several leading firms laid off over 100,000 workers in response to macroeconomic challenges and overly optimistic profit projections. Those layoffs have continued and increased in 2023, as Big Tech giants Microsoft, Facebook, Google, and Amazon kicked off a massive wave of headcount reductions, leaving another 189,500 workers unemployed.
Since its ”reckoning” began, the sector has moved aggressively to reduce its sizable real estate footprint.
Twitter has experienced the sector’s most high-profile challenges since its $44 billion takeover last April. Its leadership ordered multiple layoffs, budget cuts, and a controversial return to the office to make the firm profitable. Amid increasingly dire financial disclosures, the social network was sued by Columbia Property Trust, owner of its iconic San Francisco skyscraper headquarters, for $136,000 in back rent in January.
Subsequently, the REIT defaulted on $1.7 billion in loans for its seven-property Bay Area portfolio and saw the valuation of its properties fall from $2.34 billion to $1.6 billion in June. Local authorities also evicted the firm from its Boulder, Colorado office for non-payment.
The intensity of Twitter’s internal problems is unique, but its outsized impact on commercial real estate is not.
Since the technology space popularized the remote and hybrid work models in the decade preceding the pandemic, its industry-wide downsizing has sent the U.S. office market into a tailspin.
Why Office Vacancies Are at a 30-Year High
The tech “reckoning” has put tremendous pressure on commercial real estate; it’s not the only factor hurting the market.
In its first-quarter report on the office market, CBRE attributed the record low demand to lingering economic anxiety and the rise of hybrid work culture.
The firm determined that the amount of vacant office space eclipsed demand, with 16.5 million square feet becoming available in the first quarter. Downtown and suburban vacancies rose to 18.1% and 17.8%, respectively, with technology hubs San Francisco, Boston, and Los Angeles leading the way. Overall, companies downsizing, relocating, or being evicted contributed to a 35% drop in leasing activity from last year.
But ironically, the demand for quality office space that modern office workers want to spend time in is high.
Businesses eagerly snapped up the 5.4 million square feet of new office space delivered in Q1, and asking rents held steady at $35.42 per square foot. CBRE’s data reveals that properties in popular Sun Belt and East Coast cities proved especially appealing.
But in a buyer’s market, tenants have all the leverage and are in no hurry to sign new leases, especially in large spaces like Post-War factory conversions and aging office towers.
CBRE’s head of U.S. Office Thought Leadership, Jessica Morin, explained that the national market faces a perfect storm of adverse conditions.
“U.S. office is really being impacted by both structural and cyclical factors, structural being the increase in hybrid work that’s weakening the demand for office space and the cyclical in that people have recession fears and there’s hesitancy around taking on new space,” said Morin. “Both of those things are delivering a one-two punch to the office market that has sent vacancies up.”
Strong Employment, Subleasing, and Regional Growth Offer Hope
Despite a difficult first quarter, there are three reasons to be optimistic about the long-term future of the office market in the U.S.
The first silver lining is that a stronger-than-expected economy has pushed office-related employment to 5.4% above the pre-pandemic levels. The need for open, post-2010s style office buildings is robust, but not in sprawling college-style campuses or densely populated urban centers.
Second, subleasing activity has substantially increased due to the technology industry’s reckoning. In the first quarter, 12.4 million square feet of office space became available, pushing the total to a record 189 million square feet. As the tech sector’s reckoning winds down, its actual real estate needs are coming into focus.
For developers, all of those new vacancies represent a big opportunity. A lot of high-quality property that appeals to small to medium-sized businesses just went onto the market.
And third, Houston, Chicago, New York, and other cities have recently experienced notable increases in commercial real estate development activity. Thanks to their roots in finance and other business sectors, they’ve been spared the worst of the tech reckoning.
Recent multi-billion investments in affordable housing and steady population growth in those areas have created significant demand for new complex office and mixed-use projects.
Where Do We Go From Here?
The bottom line is that the office market as a whole won’t enter a recovery phase for several years, possibly even decades. The recent fundamental changes in how people work will suppress demand nationwide for the foreseeable future. But the broader marketplace is recovering because the economy is emerging from the long shadow of COVID-19.
With time, America’s office buildings will return to being active hubs of collaboration, invention, and innovation, but they won’t look and feel like they did in the 20th century.
Employers have accepted that retaining top talent means embracing retrofits and remodels of existing spaces, but the process is moving slowly. As corporate offices transition from endless rows of vintage gray cubicles to bright co-working spaces that accommodate smaller firms with hybrid workers, their market appeal will return.
To capitalize on the transformation of the American office, real estate developers need data-driven insights to separate that hype from reality. As last year's events have proven, past success isn’t a reliable predictor of positive outcomes in the future. But developers can find the opportunities hidden beneath the headlines by tapping into the power of analytics and proactive intelligence.
Want more insights on how to navigate the volatility of the modern marketplace? Download Northspyre’s Guide to Overcoming Real Estate’s Greatest Obstacles today.
Tag(s): Real Estate Development
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