An In-Depth Discussion on the Future of the Office Market: Insights from Phil Mobley, National Director of Office Analytics at CoStar
Introduction
In a recent conversation with Phil Mobley, the National Director of Office Analytics at CoStar, the host of America’s Commercial Real Estate Show delved into the complexities and current state of the office market. The discussion covered various aspects, including market performance, geographical trends, lease dynamics, and future opportunities. Phil Mobley provided a comprehensive analysis of the office market as it stands at the end of the first quarter of 2024, offering valuable insights into what the future might hold.
Conversation is About Office Property Nationally
Note that the conversation was national in scope, thus observations can apply less or even not at all to Miami and other South Florida markets. Most notably, the significant stress in office properties felt in major markets like New York and San Francisco has not been felt in Miami.
Current State of the Office Market Nationally
Phil Mobley began by addressing the overall performance of the office market. He noted that the headline statistics still appear troubling, with vacancy rates continuing to rise. The first quarter of 2024 saw nearly 20 million square feet of negative absorption, pushing the overall vacancy rate to 13.8%, a record high. Mobley emphasized that the challenges are not uniform across the market, as location, quality, and the type of business occupying the space significantly impact performance.
Geographical Trends
Geographically, major markets are experiencing the most strain, primarily due to the nature of the companies occupying these spaces—large Fortune 500 and Fortune 1000 companies with extensive footprints and multiple locations. Central Business Districts (CBDs) have been hit particularly hard, although suburban areas are also feeling the pressure due to a slowdown in employment growth, especially in professional services, banking, finance, and technology sectors.
Lease Dynamics
One of the notable trends Mobley highlighted was the reduction in average lease sizes. Over the past year and a half, new leases have been approximately 15-20% smaller than those in the late 2010s. This reduction reflects companies’ efforts to rationalize their footprints in response to the hybrid work environment. Companies are consolidating into pre-existing locations or moving into owned spaces, driven by the flexibility offered by new technologies that support remote and hybrid work.
Tenant Activity and Market Fragmentation
Despite the overall gloomy picture, tenant activity has shown some signs of recovery. The number of leases signed has remained relatively stable compared to pre-pandemic levels, albeit with smaller space requirements. Mobley pointed out that this increase in activity is encouraging but can be misleading, as many leases are for shorter terms and smaller spaces.
The market is highly fragmented, with significant differences in occupancy rates and tenant behaviors across different types of properties. Smaller suites in less premium buildings often have higher occupancy rates, while larger, more prestigious properties struggle with underutilization.
Opportunities for Investors and Occupiers
Phil Mobley sees several opportunities in the current market conditions. For owner-occupiers, there are favorable conditions to purchase office buildings at attractive prices. The significant reduction in new supply, which Mobley predicts will fall off a cliff in the next 18-24 months, presents a unique opportunity for developers and investors who can identify underserved markets or submarkets with a dearth of premium space.
He also highlighted the potential for distressed asset acquisition. The downward pressure on rents, particularly in markets like San Francisco, San Jose, and Seattle, where early signs of rental market resets are already visible, could offer attractive entry points for investors willing to navigate the complexities of distressed properties.
Office Property Cap Rates and Value Trends
Discussing cap rates, Mobley noted a significant divergence in market behavior. While medical office buildings and single-tenant net lease offices have seen moderate increases in cap rates, institutional-grade properties, particularly those facing distress, are experiencing more pronounced value declines. This divergence underscores the importance of evaluating each property on its merits, considering factors such as future income stream risk and tenant stability.
Final Thoughts
In conclusion, Phil Mobley emphasized the importance of understanding the nuances of the office market. While challenges remain, especially for large multi-tenanted buildings in major markets, there are also significant opportunities for savvy investors and occupiers. The key is to navigate the market with a clear understanding of the specific dynamics at play, whether it’s the potential for owner-occupied acquisitions, the strategic development of new supply, or the careful selection of distressed assets.