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If ignorance is bliss, don’t tell office landlords the latest facts on the ground about their beleaguered asset class, lest you destroy what’s left of their diminishing happiness.
A new report from Commercial Edge, a subsidiary of Yardi Matrix, a national commercial real estate analytics and research firm, found that office job growth is decelerating, the average national sales price for office buildings is plummeting, and that not only is remote work increasing across geographies, but those markets with the largest share of remote workers have the highest offices vacancies. (The report also found that Los Angeles saw the nation’s steepest decline in office prices.)
Covering all national office buildings exceeding 25,000 square feet in size, Commercial Edge’s report revealed the extent to which work-from-home patterns have accelerated over the last three years, driving up office vacancies and in turn creating distress in the asset class.
“We keep drawing comparisons back to retail and malls 20 years ago,” said Peter Kolaczynski, manager of commercial research at Yardi Matrix. “You have malls that are in a good spot, higher-end malls are still doing really well, but over the last 20 years, look at what happened to the B’s and C’s: They are now obsolete and we are anticipating the same pattern with offices.”
It all comes back to the COVID-19 pandemic. Between 2019 and 2021, work-from-home tripled from 5.7 percent of the workforce to 17.9 percent of the workforce, according to census data from American Community Survey. Perhaps not surprisingly, the metropolitan regions with some of the largest number of remote workers — Denver/Boulder (36 percent), San Francisco/Oakland (35 percent) and Austin/Round Rock (32 percent) — also have the highest spike in office vacancies today, according to Yardi Matrix.
Those three metropolitan areas have seen vacancy rate increases of 280 basis points (San Francisco), 300 basis points (Denver) and 440 basis points (Austin) over the last 12 months.
“We anticipate that there will be more distress for office properties in markets with the highest concentration of remote workers,” the report stated. “Well-positioned assets in these markets will continue to perform well, but older and poorly located properties will face the most challenges.”
While the national office vacancy average has increased from 14.9 percent to 17 percent in the last year, some cities as of June are experiencing vacancies well above the national average, according to Commercial Edge. Houston’s office vacancy rate stands at 23.2 percent; Denver’s stands at 20.7 percent; Seattle is at 19.5 percent; Atlanta sits at 19.4 percent; and Chicago is at 18.8 percent.
Moreover, office vacancies in San Francisco, Orlando, Boston and Philadelphia have all increased between 5.9 percent and 8.5 percent over the last 12 months, according to Yardi Matrix.
“It’s the same story [everywhere],” said Kolaczynski. “Less office participation, more increase in sublease space, in the bigger cities you’re just having less traffic downtown, and then you get into more commuter-driven cities — Phoenix, Dallas, Atlanta — cities with longer commutes.
“There’s still a huge drop in even the best-performing markets in actual physical occupancy in buildings,” he added.
The increase in vacancies has accordingly corresponded with slower job growth in office-using sectors such as finance and law. The Bureau of Labor Statistics found that office-using sectors grew only 1.9 percent year-over-year, and that office-using sectors have grown slower for six consecutive months in 2023.
“The deceleration in office job growth has been widespread geographically,” the report stated. “Even standout markets in Texas and Florida that were growing more than 10 percent year-over-year last summer have slowed considerably. Other markets like Chicago, Denver and the Twin Cities have turned negative.”
As work-from-home becomes increasingly entrenched and office-using job growth stalls, the next shoes to drop in the dance of doom are the average sales price of office properties and cumulative transaction volumes.
Over the last year, the average national sales price of office buildings has fallen 22 percent, from $250 per square foot to $195 per square foot, according to Commercial Edge.
No market has seen a steeper decline in average national sales price than Los Angeles, whose average sales price plummeted from $412 per square foot to $237 per square foot, a decline of 43 percent. The sale of Union Bank Plaza in Downtown L.A. epitomized this nosedive: KBS Realty Advisors sold the building at a $104 million loss in March 2023 roughly 13 years after purchasing the 40-story tower.
Quarterly office transactions are also trending lower in recent years.
After hitting a post-pandemic peak of $40 billion in sales volume in fourth quarter 2021, national office sales volumes have declined for six consecutive quarters, reaching a low of roughly $5 billion in second quarter 2023.
“Because fewer buildings are being sold, the skew will be more profound,” said Kolaczynski. “You’re seeing less buildings being transacted and they’re coming at a discount.”
Brian Pascus can be reached at bpascus@commercialobserver.com.
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