After years of turbulence, the future of the office sector is now clearer than it has been for some time. Investors who once adopted a wait-and-see approach are gradually coming to terms with the new realities of valuations and office utilization, according to the June U.S. office market report from CommercialEdge.
Most metrics that track office utilization have plateaued in the last year. Kastle’s closely tracked Back to Work Barometer has not seen any significant recent increases in the top 10 surveyed markets. Remote and hybrid work have become the standard for many firms, and this trend appears increasingly permanent. Further compounding problems for office owners is that The Fed now expects to cut the benchmark interest rate just once this year. With many owners looking to extend or renegotiate loans, rates remaining elevated for longer than expected spells trouble.
The anticipated wave of distress has still not materialized, with many factors causing pain in the office sector to slowly reveal themselves rather than hit all at once. Lease terms that can stretch up to 10 years mean that some tenants are still locked into pre-pandemic agreements and have yet to make an official decision on downsizing. Additionally, the process of negotiating extensions and modifications can take months.
According to Trepp, 6.9% of office CMBS loans were delinquent in May, up from 4% in May 2023. Our office real estate outlook predicts that distress will continue to become more noticeable through at least the end of next year.
The lack of comparable sales might have also contributed to slower sales activity. In 2021 and 2022, there were about 4,000 office transactions each year. Last year, sales fell by half to just over 2,000.
As of May this year, there have been 600 sales, an increasing number of which are being sold at discounts. In 2023, over 20% of office buildings sold for less than their previous purchase price. In 2024, this figure has risen to nearly 30%.
One silver lining for owners of existing office buildings is that the new office supply pipeline — competition for tenants in a weak market — will soon dry up, according to office real estate outlooks. Around 80 million square feet are underway currently, a figure that is much lower than in pre-pandemic years and one that will shrink further as projects deliver.
To date, CommercialEdge has recorded only 6.2 million square feet of new office construction in 2024.
The national average full-service equivalent listing rate was $37.72 per square foot in April, an increase of six cents from the previous month, but down 1.7% year-over-year, according to our latest U.S. office market report.
The rates for A and A+ office spaces have decreased by 4.3% from last year, currently standing at $44.91 per square foot. Class B office rates have inched up by 0.5% to $30.52 per square foot, and Class C spaces have seen an increase of 1.2% to $23.65 year-over-year in May.
Offices in Central Business Districts have experienced the most substantial decrease in rents, falling by 6.9% year-over-year to $47.64 per square foot. Meanwhile, urban offices saw a year-over-year uptick of 1.8% to $44.89 per square foot, whereas suburban office spaces decreased by 1% year-over-year to $30.62 per square foot.
The national office vacancy rate was 17.8%, an increase of 80 basis points year-over-year. The U.S. office vacancy rates have increased sharply in tech markets since the turmoil that upended the industry at the end of 2022. Some of the highest rates were recorded in San Francisco (25.2%, up 510 basis points year-over-year), Seattle (23%, up 350 bps) and the Bay Area (20%, up 230 bps).
Evelyn Jozsa is a creative writer covering commercial real estate trends and insights in the U.S. for CommercialEdge. She has been covering the CRE industry since 2017. Reach her via email.
