1、The Future of Office2023 U.S.Office Research ReportThe Future of Office|2Key Takeaways The U.S.office market remains relatively stagnant,but structural changes are taking shape.The office market is facing both secular shifts and cyclical phenomena at the same time.Tenants are seeking newer buildings

2、 with high-end amenities to attract and retain talent.But premium Class A assets are in short supply.Roughly 1.4 billion square feet of leases expiring before 2026 could result in nearly 300 million square feet of space being returned to the market.Repositioning and adaptive reuse opportunities,part

3、ly driven by ESG mandates,will prove fruitful.Capital is avoiding the office market today but distress is coming.Owners and investors need to navigate the changing sources of market demand,demographic trends,and lower occupancy requirements.Meanwhile,they should prepare to hold assets and deal with

4、refinancings,capital,and operational needs.The Future of Office|3IntroductionThe U.S.office market is in a state of uncertainty.Numerous headlines have discussed its demise,yet the benefits of collaboration and in-person work cannot be completely replaced via technology,particularly in creative know

5、ledge-industry sectors.The office market isnt going away,but it is affected by major bifurcations between and within markets and across building classes and business sectors.This report investigates important trends in fundamentals and capital markets today and into the future:changing work habits,d

6、emographics,and occupier demand,with both structural and cyclical factors at play.While historically the market always comes back,the definition of a“stabilized”market may have changed.The office sector and its owners are facing unprecedented pressure to adapt and evolve.Tenant Demand/New Working Pr

7、acticesChanging work habits are reshaping the U.S.office market,but exactly how is still unclear.Absorption,while positive in four of the past five quarters,has been tepid overall.With employees in offices typically three days a week,occupiers are reevaluating their space and its usage.Many,though n

8、ot all,are downsizing upon lease renewal.Occupiers decisions on space needs vary widely.Most common are space reductions of 20%to 30%,particularly when relocating,but some large companies have slashed space by more than 60%.However,others are still growing and cannot reduce space.The next few years

9、will clarify the performance of office assets:roughly 1.4 billion square feet of leases are due to expire in the U.S.before 2026.Given recent trends,a 20%space reduction could see nearly 300 million square feet returned to the market which,if not leased,could raise the vacancy rate by 500 basis poin

10、ts over the next three years.That one piece of the puzzle does not factor in growth drivers,but the market risks are formidable.Along with downsizing,occupier needs are shifting in other ways,particularly towards hybrid work.A 2022 survey by Colliers Occupier Services Group highlights this shift.Pre

11、-COVID,three-quarters of firms had an in-office policy,and only around 20%of respondents had already adopted hybrid U.S.Office Market:The Past Two YearsQ4 2022Q4 2021Q4 2020Vacancy Rate15.7%14.8%13.2%Net Absorption(MSF)Past 12 months(11.0)(52.6)(86.8)New Supply(MSF)Past 12 months42.372.361.2Under Co

12、nstruction(MSF)99.8120.5163.7Sublease Space(MSF)242.8195.6179.7Average Class A Asking RatesDowntown$51.41$51.08$50.80Suburban$33.68$33.58$32.03The Future of Office|4working.Post-COVID,77%have,or plan to,adopt hybrid work,rising to 82%among the largest firms.Occupiers are also seeking both shorter le

13、ase terms and office space design flexibility.It is unclear which occupiers will drive demand into the future,since tech firms,the key driver in many markets,are retrenching,leading to layoffs,hiring freezes,and sublease offerings.In fact,major tech employers announced more than 40,000 layoffs in Ja

14、nuary.Traditional sources of office demand,such as financial activities and professional and business services firms,are likely to be the dominant tenants seeking space in the near term.However,Wall Street firms are cutting jobs,likely curtailing leasing activity in the near term.The financial secto

15、r has the greatest emphasis on being in the office,with a four-or five-day in-office strategy.These shifts may possibly change which assets and markets interest investors and occupiers in the years to come.Florida could benefit from additional financial sector migration.Demographics and a tight labo

16、r market are also at play.Labor market conditions tend to move along with the business cycle,though demographic waves can profoundly change spending,work culture,and migration.With todays low unemployment,employees have more power to resist occupiers return-to-office goals.However,a changing workfor

17、ce could also have longer-lasting effects.As the Baby Boom generation,the largest in this countrys history,retires,it is being replaced by a smaller workforce overall essentially workers are being swapped out and working-age population growth faces near-term pressure.Without a shift in U.S.immigrati

18、on rates,it will be difficult to add net new jobs.Todays workers view technology and in-office work very differently from their Boomer counterparts.The leadership of Gen X and Millennials in organizations will reinforce flexible working arrangements.Recessionary fears are being mentioned by many pub

19、lic companies in their most recent earnings calls.It is already having an effect on growth and employment totals.Companies could use the predicted relatively lower-impact recession in 2023 to cut space and reduce headcount.On the other hand,a recession could also drive more employees back to the off

20、ice.Ultimately,the workforce may be smaller but more efficient in office attendance and space utilization.The office market is facing both secular shifts with how the office is used,and the cyclical phenomenon of a recession at the same time.77+23+I77%of companies will shift to a hybrid office appro

21、ach vs.20%pre-pandemic have set a number of days to be in the office with the majority requiring three or more days in office40+60+I40%anticipate making significant changes to their office space designs49+51+I49%have not set a Return-to-Office(RTO)date43+57+I43%will be seeking shorter term leases co

22、mpared to pre-pandemic40+60+I40%The Shift to Hybrid is RealThe Future of Office|5Vacancy and ObsolescenceFor the first time,central business district(CBD)vacancies are above suburban rates,probably a temporary trend,not a structural market shift.Markets with the strongest growth,in the Southeast and

23、 Southwest,tend to be suburban driven,but the amenities of CBDs and urban cores should eventually lure back occupiers.Until this demand rebounds,it wont be clear whether suburban outperformance is temporary.Office conversions will also help reduce the denominator in CBDs,further suppressing vacancie

24、s in the years to come.Overall,the clear flight to quality in the market has been in place for years as occupiers have sought to attract and retain talent.While absorption has been tepid overall,it never dipped into the red in properties built in the last decade.In fact,since 2012,these assets have

25、posted consistently positive net absorption quarter after quarter.The gateway CBD markets(Boston,Chicago,Los Angeles,Manhattan,San Francisco,and Washington,D.C.)lack new,modern product.In these cities,the dominant share of the inventory was built between 1970 and 1999.Occupiers want the best space i

26、n order to retain and attract top talent.This is even more important in the era of work flexibility.Experiences matter,and new buildings offer better amenities.As the evolution of ESG investing and company focus on carbon footprint boost energy-efficient buildings,assets unable to modernize and repo

27、sition themselves will fall behind.At the very least,properties need to have the veneer of quality.Functionally obsolete stranded assets,where a low-cost basis is irrelevant,are a concern in many U.S.markets.New ESG policies within national,state,and municipal boundaries will leave these assets,and

28、owners and lenders,to face devaluation pressure.Office landlords can learn from retail and hotel operators who had to find ways to evolve and capture tenants and consumers.Some office U.S.Office Market:Supply,Demand,&Vacancy Source:Colliers 10111213141516-50-40-30-20-10010203040Q42018Q12019Q22019Q32

29、019Q42019Q12020Q22020Q32020Q42020Q12021Q22021Q32021Q42021Q12022Q22022Q32022Q42022Absorption(MSF)New Supply(MSF)Vacancy Rate(%)Millions SFVacancy%35%of Inventory is Over 50 Years OldSource:Colliers 0%10%20%30%40%50%60%70%80%90%100%Washington DCSan FranciscoManhattanLos AngelesChicagoBostonPre-1970197

30、0-19992000-20142015 to dateThe Future of Office|6buildings can be converted to residences if they meet specific criteria,such as floorplate size,slab-to-slab height,and optimal location.Those with 30,000-square-foot-plus plates are hard to convert without massive capital expenditures.Numerous exampl

31、es of recent successful conversions exist throughout the U.S.,and several are underway today in markets such as Washington,D.C.,Manhattan,and Chicago.Logistics aside,repricing needs to occur for conversions to be feasible,including recent examples of distressed assets with high vacancy.In addition,l

32、ocal governmental policy and cooperation will likely be needed to promote and support office conversion activity.The majority of residential conversions will take place in CBDs,not in the suburbs.Select suburban assets can make for intriguing adaptive reuse by removing floors,or adding power for man

33、ufacturing use,or other specialized needs.But most suburban assets,not easily converted,are demolished and rebuilt.In select markets,life science conversions remain a viable strategy but are capital-intensive and would benefit from lower prices in the office market.Rents&Sublease SpaceAsking rents h

34、ave generally held up since the onset of COVID,but weakness is more apparent and concessions have increased,widening the gap between ask and take.The Class B market is starting to feel the strain.Its lower-credit tenant make-up is dominated in many cities by tech Class A Asking Rent Growth vs.Inflat

35、ionSource:Colliers,MacrotrendsSource:Gensler-20-15-10-505101520200520062007200820092010201120122013201420152016201720182019202020212022InflationCBDSuburbanGFC Impact on RentsCBD:(25%)Suburban:(9%)%Long-term averageCPI=2.4%CBD=2.8%Suburban=2.1%The Future of Office|7companies,many of which have pared

36、back space usage,pressuring occupancy,rent,and valuations.Meanwhile,Class A asking rents remain generally stable,except in specific markets.Newly constructed buildings with record rents reveal the staying power of trophy-quality assets;in 13 deals in 2022 in Manhattan rents started north of$200 per

37、square foot.One Vanderbilt has set new pricing records on its top floors.Outside of this premium space,significant concessions are offered.This means net effective rents are falling.For a new 10-year lease on Class A space in the majority of the 10 leading markets,at least one months free rent per y

38、ear of term plus a$100-per-square-foot improvement allowance has become the norm.In some cities,concessions can reach as high as 18 months rent-free and$150 per square foot toward fit-out costs.However,rising material and labor costs may force the ingoing tenant to contribute to the build-out.The ch

39、allenge to seeking shorter lease terms is that to amortize build-out costs tenants may need to accept longer leases.Sublease space continues to haunt the office market,reaching a new high at the end of fourth quarter 2022,with further increases expected.During the Great Financial Crisis,sublease spa

40、ce peaked at 40%lower than current levels.More sublease space is likely to be added faster than it can be leased,putting pressure on Class B properties and indicating future vacancy.Class A properties are not immune,either.Occupier reasoning for putting sublease space on the market has changed.Durin

41、g the pandemic,occupiers were conserving capital and offloading temporarily unused space.Today they no longer have a need for it.Direct Class A asking rents are,on average,30%more than Class A sublease space in the CBDs of top 10 markets;some,such as Houston,have a nearly 50%sublease discount,while

42、Dallas is just 16%.Subleasing will remain attractive until the business and economic outlook is more clear.Theres a greater share of quality sublease options now than in prior downturns.Capital MarketsThe capital markets face a unique point in time with elevated inflation both in the overall economy

43、 and in interest rates.Cap rates are being pushed up,with price discovery still opaque.Risk aversion about office,both on the debt and equity side,is exacerbating an already wide bid-ask spread and massively slowing down investment sales.Concessions Remain Generous*Source:Colliers*Assumes new 10-yea

44、r lease on Class A space02468101214161820$0$10$20$30$40$50$60$70$80$90$100$110$120$130$140$150$160$170$180AtlantaBostonChicagoDallasHoustonLos AngelesManhattanSan FranciscoWashington D.C.Avg.TI Allowance($PSF)Avg.Rent Abatement(Months)Sublease Space is at an All-time HighSource:CoStar020406080100120

45、140160180200220240200520062007200820092010201120122013201420152016201720182019202020212022MSFThe Future of Office|8The public markets suggest average office cap rates in the mid-to-high 7%range,to north of 8%.Institutional owners have yet to take such markdowns.This sales lull could persist for seve

46、ral quarters until interest rates and borrowing costs stabilize.The Fed remains hawkish,suggesting more rate hikes are in the offing.BBB bond rates were higher than transactional cap rates a historically uncommon trend that is not sustainable over long periods.For this spread to remain negative(lowe

47、r cap rates than BBB bonds),investors should be pricing in solid NOI gains,which in todays market are difficult to underwrite outside of the best assets.This suggests that cap rates need to rise,as the historical spread between cap rates and bonds is 2.4 percentage points(bonds above cap rates).Many

48、 occupiers are seeking shorter lease terms,which will negatively affect office valuations,as underwriting for longer hold periods will become increasingly challenging.Owners can expect higher capital costs due to tenant turnover,making properties more susceptible to business cycles.As the economy sl

49、ows from the significant risk for a recession the Fed may pivot later in 2023,allowing rates to come back down,according to a developing consensus among investors.However,this sentiment is changing.Owners cannot rely on a return to a 4%cap rate environment.Interest rates are likely to stay relativel

50、y higher,at least when compared to the past few years.Distress will emerge.Foreclosures and short sales are coming.The market is on the forefront on this.Cap rates are interest rate sensitive.Many property owners are holding on to assets unless they face a liquidity event such as a refinancing or th

51、e end of a fund lifecycle.Redemption queues are building,which could cause asset dispositions.Owners will hold onto their best product,ultimately liquidating their most challenged assets first.Even those looking to hold must prepare for capital needs and refinancings.Other long-term holders may look

52、 to disposition because of market uncertainty and offer assets with less overall competition.Theyll need to find buyers who believe in the office sector.A wave of debt maturities will force pressure on office assets because values do not support(4%)(2%)0%2%4%6%8%10%1/1/011/1/021/1/031/1/041/1/051/1/

53、061/1/071/1/081/1/091/1/101/1/111/1/121/1/131/1/141/1/151/1/161/1/171/1/181/1/191/1/201/1/211/1/22Cap Rate SpreadsCap Rate-BBB SpreadCap Rate-10-Yr SpreadBBB Spread Average10-Yr Spread AverageOffice Cap Rate SpreadsSources:Colliers,Real Capital Analytics,Federal Reserve Bank of St.LouisThe Future of

54、 Office|9current terms,so owners will have to pay out of pocket to bridge an equity gap,or find different forms of capital(mezzanine debt,additional equity participation).As some assets go back to the bank,theyll create opportunity for the vast sums of value-add and opportunistic capital waiting on

55、the sidelines.Rescue capital is being raised and will look to be deployed.This capital will have assets to pick over,and challenged loans will be moved off banks books,even if they remain viable investment targets.Winners&LosersWinners and losers are beginning to appear,and this barbell effect of pr

56、operty performance is expected to hold for the foreseeable future.Landlords and investors will have the greatest success if they can understand what“office”work now means and provide for it.While this is somewhat nebulous,its fair to say that the market is moving to a new paradigm of what work is,wi

57、th a shift toward defining work as an experience rather than a location.But it could very well go beyond that.On one end of the scale are properties with modern amenities,are ESG conscious,have modern building systems and an overall health quality within the building,irreplaceable locations,and stro

58、ng tenant draw.Outdated and underinvested commodity offices fall on the other end and may be worth simply their land value.In the middle a vast swath of U.S.office inventory will create investment and reinvestment opportunities.As owners and investors navigate the changing sources of market demand,d

59、emographic trends,and reduced occupancy,strategic business planning and understanding the ever-changing dynamics within each local market will help determine the winners and the losers.Valuations are taking hits,to the advantage of those with liquidity and nimble capital.Safety is winning today.Futu

60、re-proofing assets for institutional capital sources will be imperative.Top 25 U.S.Office Markets|Cycle Position:Q4 2022This document/email has been prepared by Colliers for advertising and general information only.Colliers makes no guarantees,representations or warranties of any kind,expressed or i

61、mplied,regarding the information including,but not limited to,warranties of content,accuracy and reliability.Any interested party should undertake their own inquiries as to the accuracy of the information.Colliers excludes unequivocally all inferred or implied terms,conditions and warranties arising

62、 out of this document and excludes all liability for loss and damages arising there from.This publication is the copyrighted property of Colliers and/or its licensor(s).2023.All rights reserved.This communication is not intended to cause or induce breach of an existing listing agreement.Authors:Aaro

63、n JodkaDirector of Research,U.S.Capital Markets+1 617 330 8059Aaron.JStephen NewboldDirector of National Office Research+1 202 534 3630Stephen.NMichael LirtzmanHead of Office Agency Leasing,U.S.+1 312 612 5933Michael.LChris ZlockiHead of Client Experience,Occupier Services,Global+1 313 595 5498Chris.ZFrank PetzU.S.Capital Markets Board of Advisors,Office Lead+1 617 330 8123Frank.P