Dive Brief:
- U.S. office leasing volumes are gradually rebounding, with more tenants returning to the market, but with major occupiers continuing to reduce their office space faster than new tenants occupy space, negative net absorption remained high in Q1, according to JLL’s U.S. Office Market Dynamics report for the first quarter of 2024.
- Out of 20 tenants with single locations spanning over 100,000 square feet of space that faced expirations in the first quarter, 13 trimmed their space while six expanded their footprints, the report states. However, the rate of tenants downsizing their space has slowed to under 12% in the past 12 months compared with 15% to 20% in the earlier stages of the COVID-19 pandemic, it notes. While the continued downsizing creates challenges for stabilizing vacancy rates, organic demand growth is gradually returning in “select pockets” of the U.S. market and will eventually help to offset the effects of previous downsizing, the report notes.
- “We’re likely to see vacancy rates continue to rise this year, though the pace will slow in the second half of the year,” Jacob Rowden, research manager, U.S. office, at JLL, said in an interview. However, with the return of larger tenants to the market, leasing is expected to grow about 15% this year, bringing volumes to 85% of pre-pandemic levels, Rowden said.
Dive Insight:
Negative net absorption occurs when tenants vacate or downsize their space at a greater rate than new tenants occupy space. Although negative net absorption “remains stubbornly high,” the report says, notional occupancy loss — negative net absorption in buildings that are leaving the office market because of planned conversion or redevelopment — is increasingly dominating the landscape.
Notional occupancy loss constituted more than 20% of negative net absorption in the first quarter and 17% of all occupancy loss since the onset of the pandemic, the report states. The firm expects that the “share of occupancy loss which can be considered notional will increase over time” as more buildings are proposed for removal.
For landlords who own the minority of office assets that have seen substantial occupancy loss and an impact on valuations, “there’s a limited path forward because it will be difficult or impossible to deploy additional capital into an asset that is already negatively levered,” Rowden said. “Ultimately, these buildings will transfer to new ownership, and in a vast majority of cases, it will be at a significantly reduced basis. Although that will cause considerable investment losses for some market participants, it’s a necessary step to rebalancing a market that is simultaneously oversupplied and undersupplied with office space,” Rowden added.
To attract new or renewing tenants in this environment, “some landlords are offering concessions like free rent and parking for tenants,” while others are looking at “upgrading and redesigning their workplaces to be more flexible and comfortable for employees, along with being more sustainable and energy-efficient,” said Tony Perez, managing director at JLL’s financial services division.
An extended period of occupancy loss is likely to continue through 2025 as many of the leases signed today still reflect downsized footprints, the report states, but as notional occupancy loss increasingly drives negative net absorption, vacancy rates could decline by early to mid-2025, JLL says in its report.
Occupancy loss is not affecting the entire market, the report states. In the fourth quarter of 2023, just 12.7% of office buildings nationally saw vacancy rates increase — the lowest percentage since the third quarter of 2017, the report states. The share of buildings with vacancy increases grew to just 13.5% in the first quarter of this year, similar to 2018-2019 rates. Office vacancies are highly concentrated in buildings that are strong candidates for conversion or redevelopment, the JLL report says, noting that 10% of U.S. office buildings account for more than 60% of vacant office space.
Converting outdated office space to multifamily units — an adaptive reuse option some landlords are contemplating — is “not a one-size-fits-all solution, since floor plates must be 20,000 square feet minimum, and it’s costly. So, bringing in experts as early as possible is vital to any reuse plan,” Perez said.
Another positive sign for landlords, the report notes, is that all office-using sectors have added new jobs in the past three months. The government and professional services sectors led the growth with 180,000 and 62,000 jobs, respectively, it says.
The demand for upgraded and amenity-rich office spaces has started to exceed a “very limited supply,” per the report, which states that the limited availability of high-end space is “not likely to abate for an extended period of time due to the absence of new office development.” Directly available space in offices less than 10 years old has shrunk by over 14% since the end of 2022 and now stands at 86 million square feet — less than the amount of new space available in 2019, JLL says.
With an influx of new workers on-site, driven by job growth, there is a growing preference for amenities like free parking, green spaces, and intelligence office and space booking systems, Perez said. The ability to “analyze occupancy trends is key for any workspace that sees changes in occupancy patterns to make meaningful, data-driven decisions that support changing workforce needs,” Perez said.
