Office Sector Questions Are Beginning to Find Answers

For the office sector, 2023 left lingering questions amid record underperformance in vacancy and net absorption. While there still may be a long way to go, Colliers’ Office Market Outlook report offered some hope, including nearly a third of markets experiencing positive absorption in the fourth quarter and asking rates, by and large, continuing to rise.

Michael Lirtzman, the CRE company’s US head of Office Agency Leasing, sees a complex picture in the fundamentals and an outlook that seems to finally answer some of the questions surrounding the sector.

A Dive into the Fundamentals

“Higher quality assets are continuing to outperform their less desirable and older peers,” Lirtzman says. “Rental rates keep increasing, but at a slower pace than the past several quarters.”

Although negative absorption persists, available sublease space is “finally beginning to recede.” From second to fourth quarters, the total available sublease space fell nearly 5% to 233.3 million square feet.

Office investment volume is down significantly, primarily due to the high interest rates and lenders sitting out the market. Perhaps as a sign of hope from recent Fed moves (or non-moves), total office sales volume rose to $14.5 billion in the fourth quarter, up from $11.5 billion in the prior three months.

On a “not surprising” note, those interest rates and increasing construction costs are shrinking the development pipeline. The 72.1 million square feet underway coming into 2024 amounted to 56% below the cycle’s peak of 164 million square feet in Q3 2020, Colliers reports.

Office Changes: Action vs. Talk

From workspaces to the workforce, the pandemic and remote work response triggered reaction and redirection in the office market. Some even called changing tenant preferences a “reimagining” of property strategies. Lirtzman reports that as hybrid work strategies settle in the pattern, there is a shift to smaller office footprints, but in higher quality assets. As for permanent product alterations?

“While there has been much written about a wave of office-to-residential conversions, we have seen very few actually executed in practice,” he says.

Meanwhile, there are some positive signals for the future of the sector. New investment activity is anticipated to pick up in the second half of the year, Lirtzman forecasts, and leasing activity should show positive signs as well.

“Vacancies will remain elevated, but negative absorption is expected to level off and turn positive in some markets,” he says. “Higher-quality assets will continue to outperform.”