Office Demand is Growing But H2 Employment Concerns Loom

Demand for office space has increased over the first half of this year but remains below pre-pandemic levels, according to Savills Research & Data Services’ State of the U.S. Office Market Report for the second quarter.

Office utilization continues to face challenges as hybrid work has become the new norm across industries and geographies. Miami and Manhattan lead the country’s return-to-office rates, followed by Atlanta and Dallas, the report said.

Many companies have instituted stricter in-office expectations, but slowing employment growth could become a factor during the rest of the year. Growth in office-using sector employment has slowed year-over-year, particularly in business and professional services, financial, manufacturing and information. Despite this, office-using jobs remains higher than before the pandemic, the report said.

However, availability continues to be elevated as sublease space is historically high. Central Business District availability is currently 25.5%, up 1,140 basis points from pre-pandemic levels. Suburban office availability has increased at a slower pace but is up 550 basis points from pre-pandemic levels to 24.8%.

“It will take time and sustained leasing activity to substantially offset the amount of space returned to the market since the onset of the pandemic,” the report said.

Leasing activity remains below pre-pandemic levels, with demand particularly focused on trophy offices with the best amenities. Effective rents have trended lower in most office markets and landlords continue to offer concessions due to fundamental market shifts and high construction costs.

Savills said it expects office inventory, which stood at 3.7 billion square feet at the end of the second quarter, to continue to increase over the next 12 months while asking rental rates and leasing activity are likely to remain flat. Available sublease space is on a downward trend that is expected to continue into next year.

The amount of office space under construction has reached a 10-year low at 83.3 million square feet. Only a few markets are expected to be negatively impacted by new supply, including San Diego, Austin, Nashville, Boston, South Florida and Seattle.

Inventory is shrinking in Baltimore, Phoenix, Chicago suburbs and Orange County, California, as a result of an acceleration of conversions and redevelopment of dated office inventory, according to the report.

Meanwhile, office investment sales activity has slowed significantly – down 59% from H1 2022 – as the cost of capital remains high. Distressed properties have been trading and a floor on valuations is being set, said Savills. Office properties represent 44% of all currently distressed commercial real estate loans.