2023: A Year of Discovery for the U.S. Office Market

The U.S. office market will have a year of discovery in 2023 as a result of measures made in response to the pandemic. There have been discussions and predictions about the gradual return to offices and possible structural upheavals even as the market shows indications of recovery.

Companies are rethinking their real estate strategy, and tenants are planning reductions of 20-30%, suggesting that a market correction may be on the horizon. Existing lease commitments constrain the ability to implement change, and economic uncertainty hinders decision making.

This Colliers report provides an overview of the national context and outlook, followed by an analysis of current economic and real estate trends in 59 prominent U.S. office markets. We also assess the outlook for each market through year-end 2023 and determine their position in the office cycle, evaluating whether local trends are declining, stabilizing, or exhibiting signs of recovery.

U.S. Office Market: Current Context

2022 closed in a downbeat fashion for the office market, with year-end numbers providing little encouragement. Net absorption turned negative in Q4 2022, vacancy rose, and sublease space hit a new record high.

As of the fourth quarter, the U.S. office vacancy rate sits at 15.7%, 30 basis points higher than in Q3 2022. Although the rate is still below the peak of 16.3% during the Global Financial Crisis, it is projected to reach that level by mid-2023 if the current pace continues.

In our national survey, 43% of the metro office markets reported positive net absorption, down from 52% in the third quarter. However, national office absorption totaled negative 14.1 million square feet in the fourth quarter, wiping out the modest gains earlier in the year and resulting in an annual net absorption total of negative 8.6 million square feet. Reflecting this shift, 12 metro markets posted negative absorption of more than 500,000 square feet. Occupancy losses in the fourth quarter were led by New York City (negative 4.3 million square feet), Greater Los Angeles (negative 1.8 million square feet), and Minneapolis (negative 1.5 million square feet). Conversely, positive absorption was led by Baltimore, Orlando, and Salt Lake City.

The U.S. office market now has a record 242.7 million square feet of sublease space available, up from 232.8 million square feet in Q3 2022 and considerably higher than the peak of 143.3 million square feet in Q2 2009 during the previous cycle. As companies continue to assess real estate needs post-COVID, sublease space will remain an attractive, short-term, cost-competitive option until there is greater clarity on future business direction.

Office construction is continuing to slow down, and the 100.6 million square feet underway is 39% below the peak of 164 million square feet in Q3 2020. The New York metro area has the most significant amount of ongoing construction, with 15.3 million square feet, followed by the San Francisco Bay Area, primarily focused on Silicon Valley, with 10.7 million square feet, and Seattle, with 7.6 million square feet.

Although asking rates are relatively stable, the difference between asking and effective rents is substantial due to generous concessions. For instance, in several major markets, tenants can receive tenant improvement allowances of $100 or more per square foot and 12 months of rent abatement in a new 10-year lease on Class A space.

U.S. Office Market: Key Observations for 2023

• The U.S. office market remains relatively stagnant, but structural changes are taking shape.
• Tenants are seeking new buildings with high-end amenities to attract and retain talent. But premium Class A assets are in short supply.
• Roughly 1.4 billion square feet of leases expiring before 2026 could result in nearly 300 million square feet of space being returned to the market.
• Repositioning and adaptive reuse opportunities, partly driven by ESG mandates, will prove fruitful.
• Capital is avoiding the office market today but expected lower interest rates in the future will attract investment.
• Owners and investors must navigate the changing sources of market demand, demographic trends, and lower occupancy requirements. Meanwhile, they should prepare to hold assets and deal with refinancings, capital, and operational needs.

U.S. National Office Forecast

• Vacancy: The U.S. vacancy rate is rising and is expected to surpass the prior cyclical peak over the year ahead. Increased building obsolescence will result in greater structural vacancy.
• Demand: Net absorption has been marginally positive in four of the past five quarters. A significant uptick looks unlikely because of business and economic uncertainty. As the tech sector retrenches, leasing will decline unless another tenant sector takes the lead.
• Sublease Space: Sublease space has reached a record high and is expected to rise as more firms cut space and put the surplus on the market.
• Construction: Development, already down 40% from this cycle’s peak, will continue to fall due to a downturn in pre-leasing and fundamentals that do not support speculative projects.
• Rents: Asking rents are holding up, but with generous concessions. The prevalence of lower-cost, high-end sublease options will place further pressure on direct rates.

Market Overview

• Vacancy rates grew to their highest level during the fourth quarter, jumping 100 basis points year-over-year, to 23.2%. Class A space outperformed as the flight-to-quality trend persisted, leaving overall vacancy 70 basis points lower, to 23.8% year-over-year.
• Net absorption returned to a positive 98,820 square feet during the fourth quarter, finishing the year at 284,877 square feet. The Woodlands submarket boasted the metro’s largest gains, 578,610 square feet, followed by Katy Freeway, 424,987 square feet, and the Northwest, 208,417 square feet.
• Landlords held asking rates firm but with generous concessions of free rent and improvement allowances. The Class A full-service rate ended at $35.46 per square foot. At $45.05 per square foot, Downtown Class A rates were 31% higher than suburban rates.
• Like Austin and Dallas, Houston had substantial growth after a rebound in the energy sector and an influx
  of people moving to the city. The city’s job growth in 2022 was notably impressive, at 5.9%, surpassing the U.S. average of 4.1%. According to Oxford Economics, Houston job growth is expected to be 1.7% in 2023 and will average an annual 1% through 2027.

Tenant Opportunities

• At 3.5%, sublease availability has steadily climbed in the last five quarters, with larger tenants reducing space.
• There is now a limited selection of large contiguous blocks of space in Class A buildings in several submarkets, including Westchase.
• Tenants’ ability to sign short-term leases will allow them more future flexibility.

Tenant Challenges

• Commute times to jobs are a factor for office workers who’ve spent more time working from home than in the office.
• The flight-to-quality trend continues, as new leases and renewals are happening the most in Class A buildings, with many tenants opting for smaller spaces.
• New developments and approved projects now find limited capital, potentially impacting ESG initiatives. Few environmentally progressive buildings are being delivered.

Click here to download the full report as a PDF.