Understanding the Nuances Behind the Office Market

The headlines spell doom and gloom for the nation’s office market. But what is lacking is distinguishing its differences, according to Cushman & Wakefield’s 2024 U.S. Macro Outlook Report.

“The office market is more nuanced than ever. Headline statistics can be misleading, and understanding the complexity of the market will be critical for both owners and occupiers to form successful strategies in the coming years,” said David Smith, the company’s head of Americas Insights.

Despite the acute downward pressure on office space that the hybrid work environment has created, and the structurally lower demand for office space per additional office worker, the report sees some kind of stability being achieved as absorption increases over time in a complex sector.

At the top of the spectrum, there is resilience and a broad flight to quality. But “there is an extraordinary concentration of weakness at the other end,” the report stated. Yet even in the face of headwinds, it contends there is underlying structural demand for office space along the quality and pricing spectrum.

“Office-using sectors and knowledge work in general are a growing share of the workforce which have countervailing impacts on hybrid work’s structural demand erosion,” the report finds. It notes the office market is in a state of transition from which a new norm will emerge. Even though change will make a portion of the office stock competitively obsolete, the share of the market it represents will be 330 million SF or less than 6% of the 5.6 billion SF Cushman & Wakefield currently tracks.

“Mathematically we are past the “post-pandemic half-way point” for lease expirations in lower quality office space and we are closing in on it for Class A,” the report noted.

Furthermore, a significant amount of downsizing has already occurred through the sublease market, which has accounted for 40% of all negative demand since the pandemic began. And with hybrid work growing, many large occupiers of office space have already ended unnecessary leases or downsized, “pulling forward behaviors that would otherwise occur when a lease ends.”

“We expect the magnitude of negative demand to lessen from -86 million SF this year to -55 million SF in 2024,” the report predicted. And it anticipated that by 2025 most firms will have completed their downsizing, allowing the relationship between job growth and demand for office space to reestablish itself. This will allow the office sector to register positive absorption once again. From 2025 through 2033 (the end of its10-year horizon), the report expects 222 million SF of net absorption to be realized.

Nevertheless, the recovery will be uneven. Top-tier offices and recently renovated assets in a prime location and with many amenities will continue to do better. But tight lending conditions and the rising cost of borrowing mean the supply of new construction is rapidly shutting down, causing demand to trickle down while value-minded tenants provide additional fuel. This would lead to stronger activity for lower quality Class A and Class B/C buildings.

“It is important to recognize that not all occupiers require or even desire trophy office space,” the report noted. “Since Q2 2020, there has been 261 million SF of leasing activity in non-Class A buildings, which accounts for roughly one-third of total U.S. leasing. This one-third portion is on par with the pre-pandemic norm.” And it acknowledges that there is a need for a range of office space quality for a diverse occupier base.

In its baseline, U.S. office vacancy peaks in early 2025 at 21.5%, up another 210 basis points (bps) from today’s 19.4%. The report estimates effective rents will decline another 5.4% in 2024, bringing the total peak-to-trough decline to 23%. Effective rent growth will resume from the second half of 2025.

Still, new construction from 2025-2027 is expected to slump to an average of under 10 million SF per year—well below the historic norm of 53.4 million SF (the 1995-2019 average). And as new development grinds down, opportunities for renovation will spring up – a trend already underway. Some 11.4 million SF of office stock is currently being improved, up from 5.6 million SF in 2019.

Emphasizing the need for nuance, the report found over half of all U.S. office buildings are still fully leased and 90% currently have zero available sublease space. In 46% of office buildings across the country, overall vacancy has not changed since Q1 2020. In another fifth of buildings, overall vacancy has actually fallen.