Office Sector at a Crossroads

JLL, Chicago, says the U.S. office market is at a “critical crossroads.”

“The U.S. office market has been facing headwinds from residual supply and demand shocks and tailwinds from accelerated vaccine distribution and exceptional economic growth projections,” the JLL first-quarter Office Outlook report said.

First-quarter dynamics were largely similar to those seen in second-half 2020, characterized by rising vacancy and falling net effective rents. “Tenants hold significant leverage and landlords are providing extensive rental abatement, termination rights and build-out allowances to maintain or attract tenancies,” JLL said.

But JLL said the sector’s liquidity has improved significantly from second-half 2020, driven largely by shifts in acquisition activity to life sciences, lab and R&D-intensive assets as well as older office product that can be repurposed easily.

VTS, New York, reported its Office Demand Index has increased to a point just 9 percent below the pre-crisis level.

“With the arrival of spring, commercial office tenants appear more than ready to start exploring spaces and imagining the possibilities for the post-pandemic office world,” VTS said. The report noted new demand for office space in core markets surged a “stunning” 19 points in March to 86 index points. That represented a 28 percent monthly growth rate, more than three times the 2018 and 2019 March monthly average.

“With the national VODI only 9 percent below the pre-crisis levels last seen in February 2020, return-to-work appears imminent,” VTS said. “The current momentum is driven by pent-up demand–tenants that postponed their space search during the height of the crisis–and deal hunters, tenants without urgent requirements seeking to lock in long-run leases at a discount. These same tenants could help maintain the growth beyond pre-pandemic February 2020 levels–a milestone possible before the end of April at current growth rates.”

But VTS also noted headwinds that could slow the sector’s momentum. “Much of the current recovery depends on our ability to put the pandemic behind us,” the report said. “A potential fourth wave of COVID-19 cases combined with stalled growth of office-using employment numbers could temper office demand growth.”

Phil Ryan, Director of U.S. Office Research for JLL, said office tour activity is “meaningfully” improving in both primary and secondary geographies as tenants begin to cement planning and workplace redesign decisions. “An intense rebound in broader economic activity will further boost prospects for the office market, although many of these gains may occur in non-office-using sectors,” he said.

In the meantime, structural changes related to increased remote work will likely have a lasting impact on the office market, “the extent to which may not be fully known until large-scale office re-entry commences,” Ryan said.