Office Occupancy Stabilized In Q3, Ushering In The Next Phase Of Uncertainty
Office leasing in the third quarter saw its first rays of sunshine since the coronavirus pandemic began, but the trajectory of the next few quarters is still clouded with uncertainty.
Net absorption for office buildings nationwide hit its best level since before the pandemic began in Q3, with quarterly research reports from JLL and Plante Moran Cresa finding negative absorption of between 7M and 13M SF, about a third of the level seen in Q2. Quarterly data supplied by Colliers found 3.3M SF of positive net absorption, representing the first positive absorption since Q1 of last year.
Roughly half of the markets for which Colliers has Q3 data had positive net absorption in the quarter. In about half of those markets, the positive absorption was less than 100K SF, suggesting the office-using economy on the whole is in a similar phase, with secondary, tech-heavy markets like Austin, Nashville and Salt Lake City seeing the most positive absorption, Colliers Director of National Office Research Stephen Newbold said.
Sublease availability contracted from Q2's record levels in the third quarter in most markets due to a combination of subleases being signed, tenants taking sublet space off the market and other tenants turning over space to landlords to be leased directly, according to multiple research reports.
Tenants reversing course on subletting space might represent the most encouraging sign for the market since that would shrink the pie of leasable space when new construction — almost universally directly leased — comes online in the coming months, Savills Vice President and Head of Americas Research Sarah Dreyer told Bisnow. Including sublease space, Savills quarterly data found that overall availability increased just 10 basis points from Q2 to Q3, a pandemic low.
“The increase in sublease availability contributed to the high levels of overall availability we’ve seen, and it’s also a measure of overall health of the market,” Dreyer said. “What we’re seeing right now as far as sublease availability is not something we’ve seen before, and it’s likely to come down first as part of the recovery.”
As sublease availability retreats, increases in direct availability will likely be driven by new deliveries, Dreyer and JLL Director of U.S. Office Research Phil Ryan said. With around 100M SF of new offices under construction as of the end of Q3, the pipeline hasn’t been this shallow since 2015 due to a major dip in construction starts as developers paused many speculative projects.
It may be premature to say the recovery is already underway, though, as the majority of companies are still working through what their long-term models of in-person, hybrid and remote work will look like. While many will redesign their spaces, amenitize them or otherwise use them to attract talent, plenty will also give back space based on a lower in-office population.
Until the balance between recommitting to offices and moving away from them is resolved, the long-term health of the office market can’t be evaluated, Dreyer and Ryan agreed.
“We’re at the point where we’ve hit the peak for subleases, which is the most important inflection point,” Ryan said. “The sense is that we’re no longer going to be in an era of rapid givebacks. Now, we’re going to be in a phase of reconsideration and longer-term thinking. We have vaccines and limited restrictions if any, so we’re able to get workers back in the office. Now, the question is, ‘How do I use that office space?’”
To the extent that office-using companies recommit to their physical footprint, they are likely to emphasize using more space for meetings and gatherings, recognizing that individual productivity has not suffered from remote work. Even more budget might be spent on amenities considering there has never been a more competitive market for talent across sectors. Newer construction buildings stand to benefit from those shifts, Ryan said.
“The newer the product, the more built-in flexibility there will be to adjust to the kind of product that people need, as well as more proper ventilation and wellness elements,” Ryan said. “That’s where things can be more easily shifted for more employee-friendly setups. If there is a war for talent and you have a design that’s more enjoyable, you have more leverage.”
The next few years will likely be characterized by a flight to quality even more pronounced than before the pandemic, Ryan said.
And when decisions start being made, it will be incumbent on landlords to understand whether their older office stock is worth revamping or whether a conversion to another use makes more sense.
“Older, more dated Class-B and Class-C properties are going to struggle in this environment, and that would certainly give owners reason to want to renovate,” Dreyer said.
In some cities like Boston and Philadelphia, seemingly any vacant office stock is a potential candidate for a conversion to life sciences. But not all buildings are physically suited for the heavier demands of lab space, and across the country, urban office buildings are more likely to be converted into apartments.
A record number of office-to-multifamily conversions have taken place this year, and Ryan said he expects that number to be broken again and again in the coming years. Though office buildings in urban cores are so far performing worse than their suburban counterparts, urban conversion is more difficult. When a suburban office park is obsolete, it is relatively straightforward to tear it down and it has many more potential uses.
Distribution centers are likely the most common target for suburban redevelopment, but expanding school districts could also make use of pre-existing buildings more easily than industrial developers, Ryan said. Residential developers are also hungry for more land to build single-family homes, and spread-out office parks present an enticing proposition.
The real push for conversion of obsolete office space and the vacancy rate bump that comes with it is likely years away, underscoring how much time the office market’s recovery from the pandemic will take. For now, the market is standing on the precipice of a new era that will determine just how long the recovery will take and how successful it will be.
“We know that the office is not dead,” Ryan said. “The question is now, what shape will it take? That’s the inflection point we’re at, more than anything else.”
UPDATE, OCT. 15, 4:45 P.M. ET: This article has been updated with finalized data from Colliers.