Urban Office Facing 'Structural Downshift' As Leases End

Offices in central business districts are facing a “structural downshift” as more and more floorpans in cities’ urban downtowns come up for lease.

“While briefly positive in the second half of 2021, omicron-induced delays to workplace return plans set net absorption back on a negative path this year,” Marcus & Millichap analysts note in a new report on the state of the office sector. “After more than two years of waiting, some companies are finally executing on lease terminations. This is especially true of mid- and low-tier space in the nation’s largest central business districts.”

Vacancies in the CBDs of primary metros climbed 550 basis points between the end of 2019 and June 2021 and have since advanced more slowly, up 30 basis points to 18.6 percent. In secondary metros, vacancy has declined 30 basis points and rents have grown by 2.9 percent.

Meanwhile, suburban properties continue to be more resilient than urban counterparts, with asking rents in the suburbs on average about two-thirds the cost of space in central business districts as of midyear. That has also allowed for the absorption of about half of the space that was relinquished during COVID-19.

Overall, though, “with more employees working remotely more often, less space is needed,” Marcus & Millichap analysts say. Occupied square feet was short 126 million of pre-pandemic levels entering 2022, with net absorption staying modest since.

“While this is keeping vacancy elevated for now, over time, demand from new companies will backfill some of the vacated space,” they say. “Staff counts have already risen above pre-2020 levels, which will help compensate for less space needed per employee.”

Marcus & Millichap predicts the national vacancy rate will tick up to 16 percent this year, as companies continue to grapple with space needs. Earlier this month, Kastle Systems Chairman Mark Ein told GlobeSt.com he was confident that average US office occupancy levels will reach 60%.

“It’s been constantly increasing, in a stair-step way, but we shouldn’t focus on the week-to-week or day-to-day,” Ein told Globe St. at CREtech. “It will get to 60%.”

Earlier this fall, Marcus & Millichap’s John Chang said that barring a major economic disruption, office employment will take years to recalibrate and realign with employment.

“It appears office space demand has structurally changed,” Chang said. “The labor shortage is key and it will like be a driving factor for commercial real estate, a factor that investors will need to watch.”