Class A office pipeline offers lifeline to asset class
The US office clearly has its headwinds, starting with delayed returns and accelerated virtual work trends. And as the back-to-work landscape changes–the average American employee spends less time working in the office–companies are likely to return to the traditional private space and increase the amount of their space for collaboration, support and approval.
However, it’s not all bad news in the office space segment. While Morningstar expects new supply to come and continued weakened demand to increase the vacancy rate over the next year, the construction pipeline is heavily laden with Class A projects that will support a continued leak to the quality.
The trend to develop better quality spaces with special attention to the provision of construction equipment demanded by tenants is likely to boost the performance of these new Class A properties, which could further widen the performance gap between Class B and C properties, which tend to be older, lower quality assets.
The amount of sublet space continues to decrease
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Several factors suggest that at the national level, the US office market is expected to rebound from the recession induced by the coronavirus pandemic, even though net absorption has underperformed.
CBRE Econometric Advisors reports that the overall U.S. office market recorded 6.6 million square feet of negative net absorption in the second quarter of 2021, bringing the total for the last four quarters to 95.1 million square feet of negative net absorption, a level not seen since the record high of 97.0 million square feet. negative absorption in 2001.
Additionally, net completions are slightly above pre-pandemic levels with 15.4 million square feet delivered in the second quarter of 2021 and 111.1 million square feet underway and are expected to be delivered over the next two years. . For this reason, the overall office vacancy rate increased to 16.5% in the second quarter of 2021, up 3.5 percentage points year-over-year (YOY).
Reason for optimism
At the start of the coronavirus-related downturn, asking rents were only slightly above the long-term average trend and not too high as they were in previous cycles, according to CBRE. As a result, there is less cyclical pressure on rents to return to the trend beyond the supply / demand imbalance, with pre-pandemic rent levels expected to be reached by the second quarter of 2022.
Accelerating trends in virtual working may affect the demand for office space less than is commonly believed. While employees may spend less time in the office, the need to meet peak traffic limits the amount of potential space reductions. While these decisions will play out over time as existing leases expire and office footfall levels are assessed, high-tech industries and markets with expensive commutes are likely to have more employees working virtually. Acquisition and loan volumes have increased.
The Mortgage Bankers Association reports that YOY transaction volumes for office buildings rebounded in the second quarter, soaring 149%, and topping the total market increase of 106%. According to the Mortgage Bankers Association, office loan origination has fallen year-over-year in each of the previous four quarters.
The volume of commercial mortgage-backed loans with balances above $ 100 million increased 53% from 2019 levels, even as the volume of loans with balances below $ 50 million increased. fell 68%. These large loans have an average loan-to-value ratio (LTV) of 57% and tend to be backed by high-quality assets with strong sponsorship and superior locations. On the other hand, for the more traditional loans, the originators withdrew, because the volume is down and the subscription has become more strict. The average LTV has deteriorated for each of the past three years, reaching 59% in 2019 from 61% in 2016.
The upper and lower markets
Unlike many previous cycles in the real estate market, the current downturn in the commercial real estate market is due more to a lack of demand than to excessive supply.
The cities best positioned to succeed in such a difficult market are those where the demand for office space is growing faster than the supply.
More secondary markets ranked in the top 15, supported by a combination of high immigration, a relatively lower cost to do business and limited new construction, while the bottom 15 have more large urban markets , who are poised to see more remote work because of higher travel costs and a higher percentage of remote jobs conducive to work.
Petra Durnin, head of market analysis at Raise, told GlobeSt: “There was a slight increase in activity at the end of the summer due to pent-up demand after the Delta hiatus during the summer. The slight slowdown in September is the counterweight to this.
Currently, tenants in the market total 3 million square feet of demand in the pipeline through 2022 “and generally the last quarter of the year is the busiest so rental activity is expected to pick up,” Durnin said.
“Tenants assess employee needs and strive to create experiential offices to attract and retain top talent. They become more and more intentional about their space, which is a longer process than before. “