What Office Space Costs Landlords and Tenants Now

Among 12 markets for which CBRE provided statistics, the highest effective rent was in Manhattan, with an average of $38.90 a square foot, a dip of 20 percent compared with the first three months of 2020. The lowest was in Houston, at $11.33, an 18 percent decline. Los Angeles was at $25.90, an 11 percent decline. San Francisco was at $35.74, a 31 percent drop; Boston at $28.71, down 4 percent; and Miami at $37.07, up 21 percent from early 2020. (Miami has been an unusually hot office market of late.)

Chicago was at $13.21, a 19 percent decline; Dallas at $12.61, a 11 percent decline; Fort Worth at $11.78, a 10 percent decline; San Antonio at $14.52, a 9 percent decline; and Austin at $25.81, a 5 percent decline. Atlanta was $17.01, a 10 percent decline. 

The figures included each market’s suburbs and not just its central business district. 

New York brokers emphasize the increasingly bifurcated market, one for state-of-the-art Class A product, which is seeing unprecedented demand, and another for the more commoditized B and C office space, where demand is soft and declining. It’s the phenomenon commonly called “flight to quality.”

The pandemic “was a huge blow to the office market,” said Ruth Colp-Haber, president and CEO of Wharton Property Advisors, a boutique brokerage that specializes in tenant representation and subleases. Fast-forwarding to today, she said “There is a flight to quality. It is a tale of two cities.”

“That hybrid element is enabling companies to reduce their footprints,” Colp-Haber said. “The idea is to find space that’s attractive, that’s fun for employees to go into, so that’s going to be in the better buildings, often with amenities. So some companies will be spending more on a per-square-foot basis but they’re getting less space.”

You “always” see a flight to quality during a downturn, said Whitley Collins, CBRE’s global president for advisory and transactional services. “Most companies feel because of the pandemic and the way we work they can take 20 or 30 percent less space,” he said. “So they move into a nicer building. So, if you cut your space by 20 percent, you can increase your costs by 20 percent. You can pay more per square foot in rent, take extra [tenant incentives]. There are a lot of companies thinking about that.”

In a December report, CBRE found that “lower tier buildings” — those in the B and C classes that have lower ceilings, a more limited array of amenities, and were built with the lower and middle markets in mind — had a slippage of 3.9 percent in effective rent in 2023, compared with a 1.2 percent loss for “upper tier” buildings. The year before, in 2022, lower tier buildings’ effective rent declined 2.4 percent, compared with a rise of 2.4 percent for upper tier buildings.

Stefan Weiss, a senior economist with CBRE Econometric Advisors, said that effective rents tend to be lower than base rents because effective rents include the impacts of whatever landlords pay to cover concessions and amenities, plus periods of free rent meant as an inducement for tenants to sign long-term leases. They also account for savings that tenants receive when rent increases are deferred until later in the lease.

“In a challenging market, landlords typically keep their base, or asking, rent firm as long as they can in exchange for more concessions to tenants,” CBRE researchers wrote in the December report.

Landlords are currently eager to give concessions to tenants, brokers say. They’re also eager to show banks the asking rents to become eligible for bigger loans.

Last year nationwide, concessions in the top tier hit $98.05 a square foot, and $85.99 for the lower tier, according to CBRE. Both are recent highs. A CBRE spokeswoman said in an email that “it’s widely known” that tenant improvement costs — which are typically shared between landlord and tenant, but that have been trending toward burdening landlords more — are at a record high, considering the rising costs of materials and inflation.

And, in a Jan. 8 report from Moody’s Analytics, effective rents nationwide were down the last two quarters — the most recent, the fourth quarter of 2023, by 0.3 percent — after eight consecutive quarters of rising effective rents. The research firm blamed “considerably high vacancies.”

What seems to be happening is that landlords, spooked by rising vacancy rates and what had been rising interest rates, were building in lounges, meeting spaces, outdoor terraces and food and beverage clusters as quickly as they could to keep tenants interested. Some lower tier office buildings are either in the wrong location or are not designed to easily convert to housing. Therefore they must do all they can to make offices work, brokers say.

“The number of offices that are primed for conversion is a very small segment of the market,” said Jessica Morin, director of U.S. office research at CBRE.

“There’s definitely more leverage in the tenant’s hands in terms of rent and concessions than there was during the pandemic,” she said. “We’re seeing some of the strongest tenant improvement allowances and free rent than we have previously seen, in both growth and commodity product.”

As for how prospective tenants should proceed, it depends. 

“You should never try to time the market,” Weiss, the CBRE senior economist, said. “Every user should make a decision based on what you need, both now and in the immediate or intermediate future. We do expect and are forecasting that the problems of the office market will [last] until the end of 2024, which in theory could lead you to say ‘Well, maybe I should wait.’ But in New York it could take up to if not more than a year between signing of an LOI [letter of intent] and finalizing a lease.”

Jacob Rowden, national research manager at brokerage JLL (JLL), said the trend toward greater concession packages mostly borne by the landlord is one that predates the pandemic anyway.

“For the past five years, we have seen this run-up for concessions packages, which are predominantly in the form of tenant improvements,” he said. “We’ve seen that grow quite a bit. It was really a way for landlords to elevate the exit cash flow on their real estate, so they were able to escalate the base rents by paying higher concessions. So, when they were selling the asset two years, three years, five years later, they had that elevated cash flow underwritten, but they had already made those capital improvements.”

Rising interest rates changed the picture, making landlords less inclined to fund concessions and amenities, Rowden said.

“Once that started to change, and interest rates were growing, there was a sense that [tenant improvements] would be under more pressure,” he said. “And we have seen that marginally decline over the past year and a half. But tenants have gotten so accustomed to these large buildout allowances, especially over the past three years during the pandemic. And now we’re in a very tenant-favorable environment.”