MARKET INTEL: Rising “IRE”: Two CRE Office Trends to Watch During Rising Inflation, Rates and Employment Cuts

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• Are office tenants shortening their lease terms again in gateway markets?
• With the economic downturn and continuation of remote work, how much office space is expiring soon and at risk?

**This research piece is created with CompStak’s exclusive data

As a follow-up to KC Conway’s blog, CRE Headwinds – Rising “IRE”: Inflation, Interest Rates, and Employment Cuts, this week CompStak is presenting four CRE trends to watch during this period of rising “IRE” based on CompStak’s best in class industrial and office lease transaction data. This week we are covering two trends in the office market. Did you miss last week’s industrial trends? 

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Are office tenants shortening their lease terms again in gateway markets as a result of souring economic news and mixed signals in the job market?

In 2022 to date, CompStak’s data does not show that tenants are turning to shorter lease terms as a result of growing concern about an economic downturn. July’s jobs report was more  positive than anticipated with the addition of 528,000 jobs and the announcement that the United States has regained all jobs lost during the pandemic.  However, unemployment weekly claims rose for the second week in a row for the week ending August 6, suggesting that the job market may be moderating in recent weeks. Still, it seems remote work and a reduced need for office space are still more impactful than concerns of a recession on office leasing decisions at this point.

In gateway office markets (Los Angeles, San Francisco, Boston, New York City, Dallas and Washington D.C.), CompStak’s data demonstrated the following:

• The average lease term for Class A space is up slightly from the 2019 average, and fully recovered from 2020’s trough.
• Meanwhile, the average lease term for Class B and C space remains slightly below the level in 2019, but showed recovery from 2020-2021 levels.

However, the spread between average term length for new deals as compared to renewals and extensions has increasingly widened since 2020. For tenants opting to renew or extend, the average term is 42.2 months among gateway office markets, significantly below 2019’s average. 

If the U.S. enters an economic downturn or remote work continues to reduce office demand over the next few years, how much office space is at risk?

In gateway markets across the United States, 2022 has been a peak year for office lease expirations, and the next two years will present a substantial supply of expirations as well. Of the leased office space in gateway markets, expiring through the end of 2032, more than 38% is expiring from 2022 – 2024, according to CompStak’s office lease transaction data. 

More importantly, the bulk of these expirations over the next several years are concentrated in office buildings built in the 1970s and 1980s, vintages said to be of less desirability to tenants in the market and at risk of “office obsolescence”.

We will discuss more on rent trends in 1970s and 1980s-era office buildings as compared to the rest of the market including new construction in our upcoming webinar with Red Shoe Economics.