Recent data shows commercial real estate investment volume falling by 26% in the US in Q3 of 2022. The FED’s hawkish interest rate strategy is making for a bear market in real estate. Debt is becoming far too expensive, and savvy investors are holding their capital to avoid overpaying for assets that won’t capitalize anywhere near what they would pay today. While all product types are in a decline, Office stands out as the struggling child in the commercial investment market.
After seeing its record high sales volume and Net Deliverable square footage in 2021, Office has taken a beating. With thousands of companies moving to work-from-home and hybrid business practices, the need for office space, large and small, has evaporated overnight. Pulling data from Costar, we found that office deliveries and demolitions have plummeted to the red in Q3 2022. In fact, more square footage of office was demolished than delivered. With Net Deliveries around roughly negative 1.5 Million, it is safe to deduce a bear market for all office product types. Costar’s forecast, which aligns well with industry data, doesn’t predict a healthy recovery in 2023. Industry experts predict dark days ahead for the office sector.
When it comes to new construction, there has been a sharp cut to any new projects started in 2022 as shown in Figure 2 from Costar.
Q3 2022 comes in under 1000 new construction projects for offices nationwide. In 2019, one of the last “normal” years we have had in a while, production in Q1-4 totals roughly 8.6 million square feet of new construction. In 2022, the gross for the first three quarters barely breaks 400 thousand. This gross discrepancy describes the dramatic change in the commercial real estate investor’s view of office. If office was still a favored product type, then it would continue to be developed. Developers are focusing on multifamily and industrial and moving away from office. It doesn’t make sense to continue to build a product type that is becoming less occupied.
So, what do we do with all these vacant buildings? With the world moving away from office, we are left with millions of square feet that are specially designed to fit a need that is now less relevant. With prices where they are right now, it is too hard to buy office buildings for any kind of redevelopment into multifamily. It doesn’t pencil to buy something at $250 per square foot and have to put another $200 per square foot minimum into it to simply make the building usable. Dirt is a better investment, and all of these vacant office buildings will remain vacant for as long as sellers demand peak pricing for their under-occupied and overvalued assets. In the long term, these buildings will need to be repurposed to fit the new demands of the market. Multifamily seems like an obvious new use, but this shift is currently prohibitively expensive. Stay tuned to see how the future of Office plays out.