Office Sector Sees Weakest Growth Outlook Among Property Types

Ten-X, Irvine, Calif., said the office sector has the weakest growth outlook of all commercial real estate sectors despite the current strong job market.

The Labor Department has reported fairly steady job growth and decreased unemployment, but the office sector has not seen much growth as a result, mostly due to changing work norms including more remote working policies and more co-working spaces, Ten-X said.

“Developers are noticing this change and the persistently high vacancies that have ensued, as the number of new offices coming to market fell 73 percent in the first quarter,” 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.” He noted office absorption slowed 39 percent in early 2019 and office vacancies have remained stagnant for five years.

Evolving technology enables more employees to work remotely and reduces office space needs, the Ten-X Summer 2019 Office Market Outlook said. “For example, cloud technology and SaaS applications have reduced the need for physical file storage space. Many companies now operate primarily digitally,” it said.

The number of new office assets coming to market will likely eclipse office absorption, pushing vacancies up to 17.3 percent by the end of 2019, Ten-X said. “Moving into 2020, the office sector is expected to continue to weaken with absorption rates continuing to falter,” the report said. Vacancies could grow to 18.3 percent by year-end 2020, the highest level since 1992. But net absorption should start to improve in 2021, it predicted.

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

Deal volume within the office sector is also decreasing, the report said. Office sector transaction volume measured just over $26 billion in the first quarter, a 13 percent year-over-year decrease.

Data from the Ten-X Valuation Index showed that U.S. office valuations should rise slightly during the remainder of the year because cap rates are weakening and office net operating income remains unchanged. But Ten-X data suggest valuations could fall 12 percent in 2020, before ultimately increasing 10.7 percent per year in 2021-2022.

“Changing office norms and a possible upcoming recession are sure to have a major impact on the office sector nationwide,” Muoio said.