Hybrid work models are expected to impact office demand as tenants continue to gravitate toward quality assets, according to research from Newmark, GlobeSt.com reports.
Newmark’s analysts have forecasted that “high-quality assets in dynamic suburban markets may hold an advantage over traditionally stable downtown assets.” Additionally, the research firm projected tenants will look for assets that have “relatively high availability, downward pressure on rents and greater demand for a vibrant worker experience.” Meeting these demands is expected to benefit the office market’s upper tier.
For example, Class A leasing activity surpassed the national average in terms of inventory share by 40 basis points during the third quarter, GlobeSt.com reports. Meanwhile, downtown markets have faltered — NCREIF suburban office vacancy was 11 percent versus an 18 percent vacancy rate for the Central Business District office market. In total, the office market has a 21.9 percent vacancy rate.
Investments in office commercial real estate has decreased, too, according to Newmark. Investments dropped 6 percent quarter-over-quarter during Q3, and the research firm does not envision sales volume to get better during Q4, GlobeSt.com reports. Office loan originations have also decreased year-over-year (23 percent) compared to 2021.
“The cost of debt is expected remain elevated,” Newmark said in its report. “Fixed finance costs are up 2.4% year-over-year, and office cap rates are likely to adjust upwards in the private market, in keeping with a sustained higher cost of debt. The combination of the highest debt costs in years, office write-downs and a large quantity of debt maturing in 2023 and 2024 makes an increase in distress likely, albeit from low levels today.”
However, less risk-averse investors might look into taking advantage of the current low prices for Class B+/Class A- buildings, according to Newmark.
The challenges the office market has faced in recent years has not deterred CRE executives, however. More than half of them still plan to invest in CRE, according to a recent Ernst & Young survey. When it comes to suburban office space specifically, two-thirds of CRE execs said they’re planning to or already are leasing it.
Additionally, the gap between CBD and suburban cap rates has tightened this year, GlobeSt.com reports. Newmark’s report noted that the better quality, Class A assets in suburban areas are doing better than the CBD office markets in 2022. Meanwhile, secondary office market yields have also closed compared to major metropolitan areas. The gap closure points to the strength of “non-gateway” markets such as Austin and Atlanta.