Office Sector Posts Weakest Growth Outlook In Q1 2019

SILICON VALLEY, Calif– Ten-X Commercial, a transaction platform powering 90% of all online commercial real estate sales, released its Summer 2019 Office Market Outlook which shows that, despite a strong job market, the office sector had the weakest growth outlook amongst all CRE sectors – multifamily, hotel, industrial, and retail. The report also outlines the top five ‘Sell’ markets for office properties nationwide.

While the U.S. Labor Department has consistently reported steady job growth and decreased unemployment for the past year, the lack of growth in the office sector is largely the result of changing work norms. These include an increase in companies implementing remote working policies that allow employees to regularly work from home, and the rise of co-working spaces.

“Developers are noticing this change and the persistently high vacancies that have ensued, as the number of new offices coming to market fell 73% in the first quarter of 2019,” said Ten-X Chief Economist Peter Muoio. “Even though more Americans are employed, it is not translating into the pace of absorption it historically has, as office absorption also slowed 39% in Q1 2019. Office vacancies remained stagnant at around 16% for the fifth year in a row.”

Another factor that has contributed to the poor outlook for the office sector is the continued rapid adoption of technology. Technology adoption has enabled more employees to work remotely while also reducing office space needs. For example, cloud technology and SaaS applications have reduced the need for physical file storage space. Many companies now operate primarily digitally.

Despite the need for less overall office space, the number of new offices coming to market are predicted to eclipse office absorption, with vacancies slated to reach 17.3% by the end of 2019. Moving into 2020, the office sector is expected to continue to weaken with absorption rates continuing to falter, driving vacancies to grow to 18.3% by year-end – their highest level since 1992. However, net absorption is predicted to improve a year later, though it may continue to fall short of keeping pace with new office offerings until 2022. In the long-term this turn will not make a noticeable difference as vacancies will remain elevated at 18.2%.

The Office Outlook also examined rent growth, which is expected to make its lowest gain since 2010, while simultaneously hitting an all-time peak of $27.29 per square foot.

“Following continued weak demand for office space, we expect rents to fall by about 2.2% in 2020,” Muoio continued. “Moving into 2021, we predict rents will average a modest 0.9% year-over-year increase, which would put rent prices just below their 2019 level.”

Deal volume within the office sector also decreased in Q1 2019 – a common Q1 year-over-year occurrence – as investors often try to finalize deals before the end of the previous year. Office sector transaction volume measured about $26.2 billion in Q1 2019, a 13% year-over-year decrease, according to data from RCA. Office pricing also declined, showing a 0.8% year-over-year loss, a 6% decrease from Q4 2018.

Data from the Ten-X Valuation Index showed that US office valuations are expected to slightly rise during the remainder of the year, as cap rates are weakening and NOI remains unchanged. Looking ahead, the data also found that valuations are expected to fall 12% in 2020, before ultimately increasing 10.7% per year in 2021-2022.

According to the July Ten-X Commercial Office Nowcast, which gauges real-time property pricing dynamics using live bidding and market activity data on the Ten-X Commercial platform, office sector pricing saw little to no change throughout the first half of 2019.

“While the office sector seems to be stalling, additional insights from our team showed that buyers still have an interest in office properties,” said Muoio. “Q1 2019 saw visits to office property display pages on the Ten-X Platform peak at just under 2,000, before falling slightly to 1,540 visitors in Q2 2019. While page views slightly decreased, it shows that buyer sentiment remains relatively strong.”

Insights from the Ten-X Commercial Platform also showed a corresponding rise in the number of visits to the secure document vaults for office properties. Q1 2019 saw a three-year high of an average of 95 visitors to the secure document vault for office properties, and average visits are continuing to trend upwards.

“This increase in average visits can be partially tied back to the trend of technology companies opening up new hubs in major cities, such as New York’s Silicon Alley. This is helping to maintain investor sentiment,” said Muoio. “However, changing office norms and a possible upcoming recession are sure to have a major impact on the office sector nationwide.”

The Office Sector’s Top Five ‘Sell’ Markets

1Q 2019 – 2022 US OFFICE SECTOR PROJECTIONS
Nashville, TN
With limited upside potential in any of the top 52 major US metro office markets, Nashville has been identified as a top ‘Sell’ market. The office sector outlook is weak across the board and the city’s rental unit prices are projected to fall 2.3% between now and 2022. Vacancies are expected to settle at 17.7%, 410 bps higher than current levels.

Dallas, TX
Despite Texas being named the state with the second-largest transaction volume nationwide – following California – Ten-X Commercial has classified Dallas as a top ‘Sell’ market. Local rent rates are expected to drop 3.1% between 2019 and 2022, alongside vacancy rates rising from 22.3% to 25%.

Austin, TX
Like Dallas, Austin’s vacancy levels are forecasted to increase, accelerating from its current rate near 13% to 16.4% in 2022. Despite the Southwest being the only region to show positive office pricing momentum, the market is predicted to continue to struggle according to the Ten-X June Office Nowcast, due to competition with shifting office environments.

Denver, CO
Even though office transaction volume in the West has been strengthening since Q1 2018, Denver is named a top ‘Sell’ market by Ten-X Commercial. When compared to Nashville, Dallas, Austin, and Chicago – the four other top ‘Sell’ markets – Denver is expected to experience the most drastic change in rent unit prices, with a decrease of 3.3% to $19.47 per square foot by 2022. Additionally, vacancy levels are forecasted to increase 220 bps to 19% by 2022.

Chicago, IL
For the third consecutive year, Chicago is identified as a top ‘Sell’ market by Ten-X Commercial in the first quarter of the year. The city continues to struggle to keep its office market afloat, with an expected 2.5% decrease in rental unit prices and a predicted 230 bps increase in vacancies by 2022.