High-End Office Buildings See Biggest Moves in Vacancy

Article originally posted on CoStar on August 21, 2023

The recent reset in office demand has rocked U.S. markets from sea to shining sea. At the midpoint of the third quarter of 2023, the national office vacancy rate hit a record high of 13.2%, a full 370 basis points higher than at the end of 2019.

Such a dramatic swing in vacancy is a powerful statement about the extensive adjustment to office demand that is still playing out. At the same time, painting with too broad a brush risks oversimplifying the story. The adaptation is not being played out uniformly across all markets, but rather varies across geographies and buildings. Some of the biggest changes are happening at the most visible buildings in the largest cities.

One way to view this is to examine different “national” benchmarks. CoStar typically reports national figures based on all types of office properties — including owner-occupied properties and medical offices. For many owners, however, a measure that excludes such properties would better reflect the competitive leasing market their assets face. For others, such as those who focus on Class A properties in major markets, an even narrower slice of inventory would be more relevant. An analysis of these two sample indices reveals important differences in how buildings have weathered post-pandemic demand shock so far.

As rapidly as office vacancy has increased in the national baseline, it has risen further at non-medical rental properties and further still at high-quality buildings in major U.S. markets. Owners competing in the traditional office space for-lease market have seen vacancy increase by an average of 550 basis points since the end of 2019, reaching nearly 17% as of mid-August. At the top-rated, four- and five-star properties in the nation’s 25 largest office markets, vacancy is now 19%, up a staggering 700 basis points from three and a half years ago.

Notably, it is only relatively recently that the major-market, high-quality vacancy rate exceeded that of non-medical office leasing buildings overall. Since the beginning of 2020, however, the gap between the two categories has widened substantially. This is due, in large part, to the addition of newly completed office space added in an environment of weakened demand.

While absorption, the change in occupied space, has remained positive in such newly delivered buildings, the lease-up of new space has slowed relative to pre-pandemic levels. Meanwhile, sublease availability in highly rated buildings has increased rapidly, with much of that space being vacated by tenants who do not currently need it.

It makes sense that shifting office demand would affect bigger markets more than smaller ones. One reason is that larger cities typically have longer, more arduous commutes, which many employees seek to avoid by working remotely as much as possible. Another is that larger employers are so far more likely to have more formalized flexible work arrangements. Since they also tend to be in premium space in larger markets, this has resulted in a stronger negative impact on demand.

Within this universe of high-quality office buildings in major markets, there are large variations by geography in how vacancy has changed over the past year, with San Francisco and Miami representing the two extremes. San Francisco’s four- and five-star buildings have lost 530 basis points of absorption in only 12 months, an incredible loss that is more than twice that of any other major market.

On the other extreme, Miami’s highly rated buildings have gained 260 basis points in positive absorption. A handful of other markets, including Boston, Charlotte and Nashville, have also managed to achieve positive net absorption at the top of their respective markets.

Miami alone, however, has seen its overall vacancy rate decrease, and even then, only marginally so. In the others, the amount of unleased new office space has been more than enough to offset leasing activity and push vacancy even higher.

The challenges facing the office market are broad, and they are especially pronounced at the high-quality, high-profile buildings in the largest markets in the U.S. Looking just below the surface of the overall trend gives a hint of how much further these market-moving properties are likely to drive the narrative in the coming months.