More than 20M SF of office space is under construction in Manhattan, and as vacancy continues to rise and leasing activity has remained well below historical levels, experts are warning about the country's largest office market being severely oversupplied for the near future.

A total of 2.4M SF of office space was leased in the second quarter, down 15% from Q1, according to a JLL report released Thursday. Total vacancy continued to rise, hitting 14.3%, according to JLL.

“It's definitely going to be an imbalance of supply and demand going forward over the next few quarters,” said Danny Mangru, Savills' research director for New York and the Tri-State Region.

Savills, which tracks roughly 467.4M SF of Manhattan inventory in its report, found that availability hit a new record high of 18.4% in Q2, despite leasing volume ticking up.

Leasing activity isn't expected to reach 2019 levels anytime soon; Mangru predicted it will probably hover around 5M SF per quarter for a while, far below the five-year quarterly average of around 8.5M SF.

“We're seeing direct space starting to increase at a very large magnitude,” he said. “A lot of that direct space is not likely pandemic-related.”

Huge office space accounting for millions of square feet — including Morgan Stanley’s 575K SF spread at 522 Fifth Ave. and 1.5M SF at 2 Manhattan West — is expected to come onto the market over the next year.

“As we look to the second half of 2021 and 2022, there's still the challenge of these large blocks of space being delivered to the market through tenant relocation and unleased new construction being delivered,” Colliers Director of Research Frank Wallach said.

Colliers and Savills declined to say which large tenants could be seeking out huge spaces, but Mangru told Bisnow they are out there — looking at both sublease and direct space.

“Large tenants within select industry segments are active with net-new expansionary requirements, and in some instances are expanding their footprints by more than 15%,” JLL New York Office Research Manager Sarah Bouzarouata told Bisnow in an email. 

Last quarter, the largest deal was the Securities and Exchange Commission’s 302K SF lease at 200 Vesey St., followed by the Legal Aid Society’s lease at 40 Worth St., both of which were expansions, according to Colliers' quarterly report. The largest new lease in the second quarter was signed by SPARC Group at Penn 11 for 156K SF, per Colliers.

With more available space and not enough activity to fill it up, the flight-to-quality trend that emerged before the coronavirus pandemic — part of what spurred the breakneck pace of office construction — has accelerated.

Eighty percent of leases signed last quarter were for Class-A office space compared to 65% in 2019, according to JLL. Of the sublease deals signed last quarter, 90% were for Class-A space.

“The pandemic's impact on workplace preferences has certainly reinforced the shift towards higher quality, well-located buildings,” Bouzarouata said.

Around 44% of Manhattan office inventory is Class-B or Class-C, while 55% of inventory is Class-A, Mangru said. The trend has already led to an onslaught of renovations as landlords hope to remain competitive in today’s market.

“If there's a Class-B space, and it's borderline Class B, B+ it's really a value-add …  that's probably going to move quicker than something that's more of a legacy building or legacy space,” Mangru said. “For those Class-B, Class-C buildings, I think they're gonna really have to reassess what kind of improvements are going to be needed or how they're going to be able to compete with the newer products on the market."

Quarterly rent rates reveal a flight to quality as well. While the asking rent has gone down year-over-year, according to Savills’ report, taking rent has gone up year-over-year, reaching $83.98 per SF, up from $79.97 in Q2 of 2020.

"[This trend] speaks more to tenant opportunity than any true increase in pricing, as the majority of deals occurring now are in high-end buildings and spaces,” Savills’ report states.

All experts say they are hopeful that the market is moving toward a recovery, especially as indicators show that office tenants are looking for workers in New York.

“The rising war for talent is expected to drive new activity, which the market has already witnessed as companies like Coinbase and Fashionphile opened new office locations in New York recently,” Bouzarouata said

Touring activity is higher than it was pre-pandemic and tenants are eager to cash in on discounts and tenant perks, according to JLL.

“We still have a long ways to go to get back to pre-pandemic levels,” Mangru said. “While we're slowly getting there, there's still a long ways to go.”