- The Federal Reserve’s efforts to combat inflation have modestly slowed employment growth, but overall, labor markets remain in expansion and national GDP growth was healthy at 2.9% in the fourth quarter of 2022. National office-using employment is now 1.3% above December 2019 levels, led by technology, advertising, media and information companies. Accordingly, technology companies drove much of the leasing activity over the last two years; however, technology firms have also been strongly reactive to the worsening economic outlook and many major employers have undertaken strategic layoffs and hiring freezes.
- Net absorption continued to contract in the fourth quarter of 2022, driven most strongly by the West. Both major gateway and secondary markets shed a comparable amount of occupancy in the quarter. The South and Sunbelt regions continue to perform well relative to the nation, though occupancy losses did accelerate in the fourth quarter of 2022. Leasing activity was again sluggish in most markets in the fourth quarter of 2022, decelerating nationally to 0.8% of inventory. Leasing activity as a percent of inventory was relatively ubiquitous across most regions and market sizes, indicating a slowdown in the momentum that had been gained in 2021 in some secondary and Sunbelt markets.
- Quality office assets continue to command the majority share of the market’s limited activity. While Class A leasing activity as a percentage of inventory is pointing downward in the fourth quarter of 2022, it exceeds the national average by 30 basis points. Additionally, Class A vacancy growth is slightly less aggressive than the overall market, increase 30 basis points relative to the market average of 40 basis points. Despite this flight to quality, Downtown markets continue to struggle. NCREIF suburban office vacancy was 10.7% compared with 18.3% for Central Business District office. With national office vacancy at 18.0%, institutional core assets are outperforming.
- Office investment activity decelerated once again in the fourth quarter of 2022, down 35.0% quarter over quarter and 66.0% year over year. Full-year volume was down 24.0% compared with 2021. Office loan originations declined 4.0% in 2022 compared with 2021 and are still down 20.0% compared with 2019. No market segment has been spared from the slowdown in transaction activity, though on the margin nonmajor markets, Suburban assets, as well as Midwestern and Sunbelt markets, has been more resilient.
- Transaction cap rates increased by 70 basis points in the fourth quarter of 2022 after months of puzzling stability in the face of rising rates and uncertainty. Further adjustments are likely, given the continued elevated cost of capital. The increase in transaction cap rates has been driven by CBD asset trades, with the result that CBD yields exceed suburban. The same is true when looking at market tiers, as major metro yields would now appear to be higher than in nonmajor metros. All of these movements have been confirmed by the debt markets, with the cost of capital for CBD assets above that of Suburban. Furthermore, the market is now showing an elevated spread between the cost of funding noncore assets.
- REIT-implied cap rates remain elevated as a result of continued pressure from higher debt costs. The REIT sector performed well in January. Even so, office REIT values are down 27.0% in the last 12 months. While the truth of valuation typically lies somewhere between the public and private markets, it seems this time that it is private markets that are starting to capitulate. According to NCREIF, office properties returned negative 18.0% in the fourth quarter of 2022, making it the worst quarter since the second quarter of 2009.
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- United States Office Market Overview
United States Office Market Overview
The United States office market continued to soften through the final 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 remained near the post-pandemic high in February of 2023.
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