There is more pain to come in the office real estate market across the U.S., with maturing debt needing to be refinanced and a wave of expiring leases, but there is also what may seem at first brush to be a counter-intuitive message being sent to top tier companies by real estate intelligence company CoStar Group: prepare for an office space shortage.
You read that right: amid a commercial real estate market across U.S. downtowns being described in apocalyptic terms, CoStar sees a shortage on the horizon, with one key caveat for top companies to bear in mind.
The more office real estate that disappears – an estimate recently given to CNBC by the CEO of major bondholder TCW Group forecasts up to one-third of office real estate still to be wiped out – the more the major players in the market will be vying for the top tier of Class A commercial space. Add to that the fact that more companies are headed back to an in-office reality closer to pre-pandemic expectations, and competition may be hotter than the weaker end of the market suggests.
CoStar’s call of an upcoming office space shortage is predicated on a look at the current data on leasing and construction activity compared to recent market history. As office occupiers scrutinize their footprints more carefully, and in the months ahead leases that were executed before the pandemic continue to approach expiration, newly constructed buildings aged 0-3 years are proving to be the winners. They have attracted over 175 million square feet of net new occupancy since the beginning of 2020, an average of 12.7 million square feet per quarter. By comparison, the quarterly average from 2011-2019 for similar properties was 11.7 million square feet. From 2008-2010, during the Great Recession, the quarterly average was 13.6 million square feet.
“Modern, premium office space remains in demand, just as it has historically, even during difficult economic times,” said Phil Mobley, national director of office analytics at CoStar Group.
Google’s mixed-use campus on New York’s Hudson River that opened in 2022 includes a two-acre rooftop and public gathering spaces.
Photos courtesy of Google
And the supply will increasingly not be there to support the demand. Currently, buildings aged 0-3 years comprise 2.4% of office inventory in the U.S. While that is in line with the average from 2015-2019, Mobley says construction has slowed dramatically. Less than 30 million square feet has broken ground in 2023, making this year the lowest for construction starts since 2011. Today, there is about 200 million square feet of office space in buildings aged 0-3 years, but that figure will be under 150 million by early 2026 and under 100 million by the middle of 2027. At that point, it will represent only about 1% of inventory. Even in the aftermath of the Great Recession in 2013-2014, buildings aged 0-3 years never represented less than 1.3% of inventory.
“The very type of space that tenants have historically demanded most — even during recessions — will be in short supply,” Mobley said.
This isn’t to say there won’t be more headlines about trophy buildings being sold at discounted values. But those transactions also mean that now is a time when tenants are getting good deals. The number of new lease transactions is higher this year on a quarterly basis than the 2015-2019 period. Deals are smaller in square footage – which explains why overall market vacancy is up – and expiring leases are part of the reason for the uptick, too. Still, the deals are “highly concentrated” in the premium space, Mobley said.
Meanwhile, landlords of iconic, trophy buildings are offering sweeteners, from bigger contributions to custom buildouts to the number of months offered rent-free. It’s not clear how long that will last, though. As more top buildings are sold at depressed values, investors mark down the value of property holdings, and bonds go bad, new owners can make their finances work with attractive terms to tenants. But for building owners who will need to refinance in the near-term, that game is ending. Case in point: a recent deal for the City of Los Angeles to occupy multiple floors in the iconic Gas Co. Tower, a deal which would have comprised 11% of new quarterly leasing activity in the market, was rejected by bondholders.
Billionaire real estate investor Jeff Greene explained his bet on new towers in West Palm Beach, amid the correction he sees coming for much commercial real estate in the next two years, in the following way during a recent CNBC interview: “There will just be office buildings with no tenants whatsoever in markets where brand new building will get the tenants. … Some of the older buildings just won’t have any tenants at all, and if there’s no tenant at all for a prolonged period of time, that paper [the bonds] will be worth next to nothing.”
The U.S. housing market never recovered from the financial crash as measured by the inventory levels today, one factor responsible for pushing up home values across the country. But Mobley says there is a better parallel for the office space crash: the retail washout, which was overbuilt, and has not been built much since e-commerce disrupted the sector. While Class B malls are still sitting vacant, high-end “experiential” retail is not.
“That’s the parallel for office,” Mobley said.
CoStar estimates there is still over half of leases executed before 2020 set to expire. “As companies face these renewal decisions, they are now laser-focused on utilization,” he said. That implies a world in which tenants may need less space, but as they continue to make the case for the world of work to return to pre-pandemic in-person collaboration, competition for the best square footage in the market is heading higher.
For companies facing lease expirations that believe in the notion of the office as a tool to help maximize workforce effectiveness and, as a result, want to be in premium locations — and not the 10-20 year-old iconic buildings but the newest properties – some of the best opportunities are now, Mobley said.
TORONTO – One expert predicts Ottawa‘s changes to mortgage rules will help spur demand among potential homebuyers but says policies aimed at driving new supply are needed to address the “core issues” facing the market.
The federal government’s changes, set to come into force mid-December, include a higher price cap for insured mortgages to allow more people to qualify for a mortgage with less than a 20 per cent down payment.
The government will also expand its 30-year mortgage amortization to include first-time homebuyers buying any type of home, as well as anybody buying a newly built home.
CIBC Capital Markets deputy chief economist Benjamin Tal calls it a “significant” move likely to accelerate the recovery of the housing market, a process already underway as interest rates have begun to fall.
However, he says in a note that policymakers should aim to “prevent that from becoming too much of a good thing” through policies geared toward the supply side.
Tal says the main issue is the lack of supply available to respond to Canada’s rapidly increasing population, particularly in major cities.
This report by The Canadian Press was first published Sept. 17,2024.
OTTAWA – The Canadian Real Estate Association says the number of homes sold in August fell compared with a year ago as the market remained largely stuck in a holding pattern despite borrowing costs beginning to come down.
The association says the number of homes sold in August fell 2.1 per cent compared with the same month last year.
On a seasonally adjusted month-over-month basis, national home sales edged up 1.3 per cent from July.
CREA senior economist Shaun Cathcart says that with forecasts of lower interest rates throughout the rest of this year and into 2025, “it makes sense that prospective buyers might continue to hold off for improved affordability, especially since prices are still well behaved in most of the country.”
The national average sale price for August amounted to $649,100, a 0.1 per cent increase compared with a year earlier.
The number of newly listed properties was up 1.1 per cent month-over-month.
This report by The Canadian Press was first published Sept. 16, 2024.
MONTREAL – Two Quebec real estate brokers are facing fines and years-long suspensions for submitting bogus offers on homes to drive up prices during the COVID-19 pandemic.
Christine Girouard has been suspended for 14 years and her business partner, Jonathan Dauphinais-Fortin, has been suspended for nine years after Quebec’s authority of real estate brokerage found they used fake bids to get buyers to raise their offers.
Girouard is a well-known broker who previously starred on a Quebec reality show that follows top real estate agents in the province.
She is facing a fine of $50,000, while Dauphinais-Fortin has been fined $10,000.
The two brokers were suspended in May 2023 after La Presse published an article about their practices.
One buyer ended up paying $40,000 more than his initial offer in 2022 after Girouard and Dauphinais-Fortin concocted a second bid on the house he wanted to buy.
This report by The Canadian Press was first published Sept. 11, 2024.
