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  • Writer's pictureAndre Watson

Demand for office space remained weak in Q2, but some sectors buck trend


New construction and weak office-space demand in the second quarter pushed the national office vacancy rate to 18.2%, according to CBRE.



Office leasing demand remained tepid in the second quarter, as the economy's trajectory is uncertain and companies continue to figure out their post-pandemic real estate needs.


VTS Inc.'s Office Demand Index, or VODI, recorded new demand for office space in the second quarter at 53% of its average level in 2018-19, while CBRE Group Inc. (NYSE: CBRE) found negative absorption nationally in the same three-month period.


The VODI, which primarily tracks office-space interest and demand in major markets, declined 15.9% on a quarterly basis — a seasonal trend that's typically observed, but this decline was more pronounced than in years prior.


The VODI's findings come from VTS's leasing platform, software used by landlords to record, capture and aggregate supply and demand data. It's intended to serve as a leading indicator of office demand by capturing upcoming office leases and tenant sentiment rather than done deals.


There were, however, some glimmers of rebounding tenant demand in the second quarter — including in San Francisco, an office market that has been disproportionately affected by remote-work trends spurred by the Covid-19 pandemic and an overall slow recovery in its downtown.


According to the VODI, San Francisco saw 10.2% quarter-over-quarter growth and 5.9% yearly growth in tenant interest. Since March, the Bay Area market also has seen an increase in the number of new prospective tenants seeking spaces larger than 50,000 square feet.


Max Saia, director of investor research at VTS, said the ongoing buzz around artificial intelligence has prompted a surge of new companies in the space to form and attract capital. Those ventures tend to be clustered in the Bay Area, and the uptick in space demand likely is coming from those startups.


"(The Bay Area) is still an amazing market for AI research talent, so there’s no better place to start a company focused on that than San Francisco," Saia said.


Across other major markets tracked by VTS, tenant demand increases are generally coming from more traditional industries, like finance and law, rather than tech, he added.


It remains to be seen whether the proliferation of AI, along with firmer stances by major tech companies like Amazon.com Inc. (Nasdaq: AMZN) to bring workers back to the office, will continue to influence office-space demand from tech companies.


"We're looking for additional confirmation in the data that the trend of AI demand in San Francisco has legs," Saia said. "We need to see continued months of growth to feel confident that’s a sustained trend."


On a yearly basis, New York saw an increase in tenant demand by VODI metrics, a 7.4% jump from the second quarter of 2022. Because that market is very diversified, Saia said, a number of industries are driving demand there, including more traditional occupiers like financial services.


Although it's not formally included in VTS's tenant-demand reports, Houston is another market the firm tracks that's seeing signs of growing tenant demand, Saia said. That's likely bolstered by growth in the energy sector — which drives the office market in Houston — as larger firms in that industry have entered the market this year.


CBRE found the Houston market saw more than 2.1 million square feet of leasing volume last quarter and office-space absorption of 313,000 square feet, outpacing all other major Texas metros in the second quarter.


Among the markets tracked by the VODI, Boston saw the greatest quarterly decline in tenant demand, a rate of 50.9%, but VTS attributed that to the Massachusetts city having seen its VODI peak in Q1. Still, its year-over-year decline in tenant demand was 39.1%.


Other Q2 space findings

New construction and weak office-space demand in the second quarter resulted in negative 8.5 million square feet of net absorption in the second quarter, pushing the national office vacancy rate to 18.2%, according to CBRE.


Downtown markets had a vacancy rate of 18.5% compared to 18% in the suburbs as of Q2, indicating space demand is weakening similarly in both urban cores and suburban submarkets.


Leasing activity last quarter fell 3% from Q1 among markets tracked by CBRE and fell 33% from Q2 2022. The average size of leases completed in the first half of 2023 was 28% smaller than the average seen in the first half of 2018 and 2019.


As for sublease space, that hit a new high in Q2 at 194 million square feet, according to CBRE. The sublease growth rate has slowed, to 2.9% between Q1 and Q2 compared to 7.1% between Q4 2022 and Q1 2023, but it's nearly 25% higher than the rate a year ago. The markets that saw the biggest increases in sublease space in the second quarter were Atlanta, Salt Lake City, Seattle and Charlotte, North Carolina.



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