- The Federal Reserve’s efforts to combat inflation have modestly slowed employment growth, but overall labor markets remain in expansion. National office-using employment is now 3.9% above pre-pandemic levels, led by technology, advertising, media and information (TAMI) companies. Accordingly, technology companies accounted for 40.5% of all leasing activity through the third quarter of 2022; however, technology firms have been somewhat reactive to the worsening economic outlook and have undertaken strategic layoffs and hiring freezes.
- Net absorption continued to contract in the third quarter of 2022, equitably driven by both major gateway and secondary markets. Occupancy losses have been a reflection of the low leasing activity in recent quarters. Leasing activity further contracted in the third quarter of 2022 as the weight of economic uncertainty further suppressed real estate decision-making.
- Tenants are continuing to support flight to quality, as evidenced by the above-average performance of higher-quality office assets. Class A leasing activity as a percentage of inventory exceeded the national average by 40 basis points in the third quarter of 2022. Despite this flight to quality, Downtown markets continue to struggle. NCREIF suburban office vacancy was 11.0% compared with 18.0% for Central Business District (CBD) office and 21.9% for the office market as a whole.
- Office investment activity decelerated once again in the third quarter of 2022, down roughly 6% quarter-over-quarter. While year-to-date sales volumes are on par with 2021, activity in the fourth quarter of 2022 is likely to be weak and certainly weaker than the record volumes achieved in the fourth quarter of 2021. Office loan originations are down about 23% year-to-date compared to 2021. Sun Belt office assets continue to exhibit the greatest liquidity relative to the pre-pandemic trend.
- Overall transaction cap rates have been stable, but there have been some relatively notable shifts within the office market. The spread between CBD and suburban cap rates had closed in 2022. Higher-quality, Class A assets in suburban markets have performed better than CBD office markets thus far in 2022. Similarly, secondary office market yields have closed relative to major metros, highlighting the strength of non-gateway markets, including Dallas, Austin, Atlanta, et cetera.
- In contrast, REIT-implied cap rates have increased sharply, driving a sell-off in office REIT values, down about 35% year-to-date. As noted, appraisal- and transaction-based measures of value have been much less reactive thus far; however, this is beginning to change. According to NCREIF, office total returns have decelerated sharply, with CBD office turning negative in the third quarter of 2022.
United States Office Market Overview
The United States office market continued to soften through the third quarter of 2022, weighed down by growing economic headwinds and continued caution among occupiers to undertake long-term, growth-focused office commitments. Despite these challenges, in-office occupancy has risen to a post-pandemic high in November.