Secondary markets drove the absorption of office space in the second half of 2021.
Despite a relatively strong end to the fourth quarter, office investors are still likely to remain on the sidelines in primary markets as rent remains flat and outpaced by inflation and high borrowing costs.
A new analysis from research economist Scholastica Cororaton of the National Association of Realtors predicts that secondary office markets will continue to drive demand in 2022 as they did last year. The fourth quarter saw 14.5 million square feet in absorption, an improvement over Q3’s 5.6 MSF. But “given the massive amount of space given up during 2020 Q2 through 2021 Q2, office occupancy is still down by 117.8 million square feet as of 2021 Q4,” she says.
Citing CoStar data, Cororaton notes that “secondary markets drove the absorption of office space in the second half of 2021,” led by Atlanta (3.3 MSF), Austin (2 MSF), San Jose (2 MSF), Dallas-Fort Worth (1.9 MSF), Houston (1.3 MSF), Seattle (1.3 MSF), Palm Beach (1.1 MSF), and Nashville (1 MSF).
By contrast, Chicago, New York, and Washington D.C. all showed losses in office space occupancy. Notwithstanding a relatively improved second half of the year, 117. 8 MSF of office space remains unoccupied, with at least 10 MSF of office space released to the market since 2020 Q2 across New York (-29 MSF), Los Angeles (-10.5 MSF), Washington, D.C. (-10.2 MSF), San Francisco (-9 MSF), Chicago (-8.2 MSF), and Boston (-5 MSF).
“The office market will continue to see significant headwinds in 2022 arising from the impact of inflation on investor office acquisitions and the effect of the omicron variant on office re-entry,” Cororaton writes. “The high inflation rate is likely to have an impact on office acquisitions in metro areas that are suffering large office vacancy rates, which are mainly the major office markets. With inflation currently hovering at 7%, with construction costs up 15%, and with a tight labor market with wage growth hovering at 4.5%, investors are facing negative real returns. Rents are not likely to rise on pace with inflation in the primary major markets of New York, Chicago, Washington, D.C., Los Angeles, and San Francisco given the large vacancy rate in these markets. So, expect investors to remain on the sidelines in these markets.”
That aligns with reports from late last year, which pointed to suburban assets continuing to be the focus of investor favor. Buyers socked more than $25 billion into these properties in the third quarter alone, while just $9.6 billion was allocated to CBD locations. Boston was the most active city for office investment in the first three quarters of the year, according to Colliers, with $8.5 billion of sales closed. San Jose and Seattle followed behind at $4.9 billion and $4.8 billion, respectively.