The US office market has been experiencing a period of softening, driven by cautious occupiers and investors in the commercial real estate sector. Amidst potential economic slowdown, companies have been adopting defensive postures, leading to layoffs and reductions in office portfolios. This trend has been particularly pronounced in the technology sector, which accounted for over 60% of public layoff announcements among US companies in the last six months.
Leasing Volume and Occupancy Rates in Commercial Real Estate
Leasing volume fell for the third consecutive quarter in the commercial real estate market, but strong activity from the first half of 2022 kept rolling 12-month volume 2% higher nationally. However, the leasing decline in Q1 was driven primarily by corrections among key growth industries, delaying of large-scale activity, and a diminished pipeline of new requirements as tenants exercised caution.
Vacancy rates reached a record 20.1% due to new sublease additions. Despite these challenging market fundamentals, national asking rents in commercial real estate continue to grow, indicating a continued demand for office space.
Economic Landscape and Market Volatility in Commercial Real Estate Development
The economic landscape has been rife with challenges for commercial real estate development. In March, the failures of Silicon Valley Bank, Signature Bank, and Credit Suisse injected newfound volatility into the market. This led to direct impacts on client tenants whose financing was put in jeopardy and growing concerns that the diminution of office values over the past year will lead to further credit challenges for banks with large commercial real estate exposure.
Inflation and Interest Rates: Impact on Commercial Real Estate Construction
While inflation remains elevated, year-over-year inflation has fallen more than 400 basis points from peak levels in June 2022. To combat inflation, the Federal Reserve has deployed the most aggressive increases to interest rates in over 40 years. However, expectations for future rate increases have shifted and gained uncertainty. Investors now expect rates to peak in the next two months and begin declining in earnest through the second half of the year. This has significant implications for commercial real estate construction and development.
Return to Office and Productivity: Documentation of New Trends
Despite the cyclical headwinds, there is a positive secular growth story. As labor markets soften and companies refocus on efficiency and productivity, return-to-office efforts continue to progress incrementally across major US markets. A wave of major employers in key industries including technology, media, finance, and professional services has announced reversals of remote work policies or increased frequency for hybrid workers. This trend is well-documented and is expected to shape the future of commercial real estate.
The US office market faces mounting cyclical challenges today, which have hampered a full recovery from the pandemic. However, the peaking and eventual easing of interest rates will be a welcome development for office occupiers and investors alike. Despite the current challenges, there is a strong demand for high-quality differentiated offices, indicating a promising future for the US office market and commercial real estate development.