Finance  ·  Analysis

U.S. Office Asking Rents Increase Despite Higher Vacancy

New national report from Newmark argues landlords are holding off leasing space at lower rents out of fear of depressing building values

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Despite vacancies for all office classes reaching nearly 20 percent – and the national availability rate rising to a record 24 percent – asking office rents somehow rose in the fourth quarter of 2023, defying supply and demand expectations, according to a new report from Newmark (NMRK)

The Newmark report noted that rents for office space have typically decreased in past downward cycles to account for a slip in demand, but national office rents have largely held steady since the onset of the COVID-19 pandemic four years ago. 

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In fact, overall office rents rose 1.1 percent year-over-year in the fourth quarter of 2023. 

“The reason for that is the market hasn’t adequately repriced rents,” said David Bitner, executive managing director of global research at Newmark. “Asking rents have gone up even though we’re at all-time record vacancies. It basically defies supply and demand, and there’s some Econ 101 problems with that, which just says reality is more complicated than models.”

Bitner noted that, in reality, landlord concessions have risen in recent years, with tenant improvement packages doubling in most markets since 2019, and that there’s also “a fair amount of strategic vacancy in effect,” with office owners refusing to lower rents in vacant space out of fear of depressing building values with reworked leasing packages. 

“If those [new] renters are sufficiently far below your in-place rents, it will adversely impact the value of your building more than the additional NOI [net operating income] you can get,” explained Bitner. “That’s just the way the valuation models look at it and how the lenders look at it.” 

Perhaps one reason why office owners are willing to hold on to so much vacant space is because such a large chunk of their existing space isn’t being utilized. Aided by Kastle Systems data of a 10-market average, the Newmark report showed return-to-office attendance peaked at 54.1 percent in mid-November 2023, before falling to 48.5 percent in January 2024 following the holiday season. 

Newmark concluded that those percentages are unlikely to change as we move further away from the pandemic. 

“We’re definitely seeing a stabilization between what employees would like to do with work-from-home and what employer exceptions are,” said Keith Reichert, director of research at Newmark. “That trend will continue. We won’t see a huge return to office anytime in the near future.” 

National office net absorption – the difference in the amount of space leased from the amount of space vacated – reached negative 8.2 million square feet in the fourth quarter of 2023, according to Newmark. While that is significantly less negative absorption than any of the last five quarters, it doesn’t cover up the fact that net absorption for office has totaled negative 257 million square-feet since the first three months of 2020, when the pandemic began. 

By comparison, national office net absorption totaled negative 51.6 million square feet during the Great Recession of 2008 to 2010 and negative 75.7 million square feet during the early 2000s dot-com crash.

Reichert conceded that while the negative 257 million square feet is a large number, on average the national net absorption levels have improved nearly every quarter since the onset of the pandemic in early 2020. 

“It’s been improving, so in my opinion this is a market correction,” he said. “We’ve hit the bottom and now we’re getting better over time, essentially.” 

What might be most concerning among the Newmark data is the persistently high vacancy rates for office. Vacancies for Class A office space rose 220 basis points year-over-year in the fourth quarter of 2023, and the national rate for all classes stands at a record 19.6 percent. 

Bitner said that the combination of a slow delivery pipeline across regional markets and the lack of transactions have kept a long-awaited office sector recapitalization at bay and will combine to lock in high vacancies over the next two years. 

“We’ll see [vacancy] continue to rise probably into 2025, which is consistent with a lot of forecasts you’ll see,” said Bitner, who added the delivery pipeline is dropping across all markets and will likely help vacancy trend lower in the long term. “New product is generally well bid, there is this trophy focus, and the new buildings are trophy by definition, so we think they’ll lease up. The question is where do the other tenants come from?”

Tenants are likely to make an organic shift upward. 

Bitner emphasized that the market needs to go through a secular shift in occupancy, as tenants in the Class B and Class C buildings move out of derelict offices whose values have plummeted and into newer, better Class A space – in turn increasing vacancy across those lower classes of office but closing the vacancy gap in Class A space that’s worth leasing. 

“We’re already in the behavioral new normal around hybrid work, but the office market is still in the early innings of going through the necessary adjustments that will fall out of that,” explained Bitner. 

“There’s still nearly three-quarters of pre-pandemic space that hasn’t come up for renewal in a dramatically different working environment,” he added. “We think this will be a very core factor shaping the leasing markets through the end of the decade.” 

Brian Pascus can be reached at bpascus@commercialobserver.com