Office Development Perseveres Amidst Property Market's Challenges

The metropolis of Austin, Texas presents a glimpse of a larger enigma encountered by an already embattled U.S. corporate real estate market—erection of novel expanses persists unabatedly, even as appraisals dwindle on current properties, and a growing number of companies strategize for diminished, rather than expanded, office space.

Key TakeAway

• Abundant lease accessibility, escalating vacancies, and plummeting market appraisals haven't dissuaded fresh office fabrication.
• Inquiring rents in certain markets don't mirror market circumstances, but they're probably descending.
• Amid substantial corporations downsizing office operations, does the market necessitate supplementary space?

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Austin Office Market Flourished Amid the Pandemic

The bustling metropolitan area of Austin, Texas, harbors an extensive expanse of seventy million square feet dedicated to office spaces. Within this vast landscape, a notable twenty-eight percent remains unoccupied, eagerly awaiting potential lessees.

Nevertheless, in this current year, the thriving Austin market has welcomed the introduction of newly created premises, encompassing a substantial area of 657,139 square feet. Furthermore, an impressive 5.5 million square feet is currently undergoing construction, amplifying the growth momentum. That's not all—a remarkable 11.8 million square feet of additional space is planned according to existing building blueprints.

Even as the pandemic surged, Austin continued to assert its dominance as one of the most coveted office markets nationwide, exhibiting an upward trajectory. Prominent companies such as Tesla (TSLA), Amazon (AMZN), Apple (AAPL), and Google (GOOGL) avidly scoured the region for potential locations to establish offices for their relocating workforce from California and other areas. Concurrently, local developers seized the opportunity and initiated construction on speculative buildings, aiming to capitalize on the fervor.

Office development, ultimately, necessitates extensive groundwork and meticulous preparation, and once the process commences, halting becomes a formidable task. In the majority of instances, progression was the sole feasible course of action. However, a paradigm shift occurred with the emergence of remote work practices in Austin and throughout the nation, leading to a surge in vacant office spaces.

"It is indeed accurate to assert that we require reduced space," expressed Jessica Morin, the esteemed leader of U.S. Office Thought Leadership at CBRE, a distinguished enterprise specializing in commercial real estate and investment services. "Yet, the paramount question remains: to what extent should this reduction be?"

 

Unabated Construction

Across the entire nation, office construction continues unabated, with a staggering 118.2 million square feet currently under development, representing 1.8% of the existing office space. Remarkably, over a fifth of this space remains available for lease.

When combined with forthcoming construction projects, the office space landscape is projected to witness a significant growth of 5.6% in the upcoming years.

This influx of additional space will materialize even as prominent corporations outline plans to reduce their reliance on office premises in the coming years.

A comprehensive survey conducted among executives overseeing real estate matters at 350 multinational companies, boasting a collective workforce of 10 million individuals, unveiled that half of them intend to downsize their office space within the next three years, with some planning reductions of up to 20%.

Simultaneously, there has been a notable decline of 22% in postings for non-remote job positions—roles that traditionally require office space—over the past 15 months.

Concentrated Vacancies

The distinctive characteristics of office properties help elucidate the persistent rise in construction, despite the decline in office property values, escalating vacancies, and seemingly ample availability.

According to research conducted by CBRE, a remarkable 10% of all office buildings within its monitored markets accounted for an astounding 80% of the total square footage occupancy loss from the onset of the pandemic until the conclusion of 2022. These particular buildings, referred to as the "hardest-hit buildings" by CBRE, typically occupy regions with relatively higher crime rates and fewer nearby amenities. While not necessarily aging structures, many of them are situated in downtown markets, predominantly in the Northeast and along the West Coast.

Furthermore, property owners and construction firms are obliged to plan for projected space requirements years ahead. However, these plans may not accurately align with present needs, resulting in a discrepancy between ongoing and planned construction and the immediate market conditions.

Rents Don't Reflect Market Realities—Yet

Nevertheless, there remains uncertainty as to whether property owners have fully acknowledged the prevailing market realities.

For instance, in the vibrant city of Austin, the average asking rent for existing office space stands at $51 per square foot—an astonishing 27% higher than the nationwide average.

This disconnect becomes even more striking in the colossal market of New York City. In Manhattan, the average asking rents reach a staggering $88 per square foot, which surpasses the nationwide average by more than double, despite a fifth of all available space being up for lease.

Admittedly, it is customary for rents in the New York market to exceed the national average. However, the current asking rates persist, even in the face of a joint study conducted by Columbia University and New York University, predicting that if remote work practices do not revert to pre-Covid-19 norms, the city's property values by 2029 will remain less than half of what they were in 2019.

Nevertheless, when adjusted for inflation, CBRE's data indicates that rents have experienced a significant decline of 15% from their pre-pandemic peak. The firm further projects that "real" rents, adjusted for inflation, will undergo another 10-12% decrease within the next 18 months to two years before eventually stabilizing.