The U.S. office market is expected to edge downward slightly next year, along with slowing in economic growth, according to the 2019 Broker Sentiment Survey from real estate services firm Transwestern. The survey, which considered occupancy, rents, development and leasing velocity, resulted in the overall average U.S. office index ticking down from 112.9 in 2018 to 111.2 nest year, indicating flat growth.
The current real estate cycle is expected to continue through 2020, with brisk economic activity and steady job growth driving leasing velocity and asking rents higher in most U.S office markets. However, the tight job market could make it difficult to attract and retain educated workers, limiting some the growth for some office occupiers and expansion in space, notes Elizabeth Norton, managing director of research at Transwestern.
The survey also revealed the high value today’s office tenants place on amenities, with nearly 87 percent of surveyed brokers citing access to public transit or parking as tenants’ highest priority, followed by reliable WiFi service and walkable dining/retail options and other amenities (69 percent), an on-site fitness center (48 percent) and conference facilities (45 percent).
A Transwestern economic briefing noted that Congressional gridlock following the November election reduced the likelihood of political or economic policy changes for the next two years, which will lead to continued economic growth, but at a slower pace. Norton warns, however, that the recent political turmoil could create economic uncertainty and slow consumer spending. “When consumerism slows, a driver of the economy, it in turn impacts the office market,” she adds.
The survey also reflected tenants’ flight to quality and transition to the use of creative office spaces. Creative office solutions have, in some cases, resulted in allocation of less space per employee than historically, as fewer people need to work on-site at any one time.
Bob O’Brien, leader of the global real estate sector with consulting firm Deloitte, cites emerging trends that will further challenge office owners in the coming year. The flight to quality is aligning with the downsizing of space needs, resulting in fewer tenant renewals. “The easiest way to implement a smaller space is to move to a new space, rather than reconfigure the old one,” he notes.
Offers of free rent and other incentives are allowing tenants to take up smaller spaces in new or upgraded buildings for about the same rent they are currently paying, O’Brien adds. But while older buildings will suffer from the flight to quality in markets where there is not enough demand to backfill vacated space, in markets with little new development the dynamic should benefit owners of existing buildings.
Recognizing that their space needs may change, tenants are also increasingly asking for shorter than traditional lease terms, which is thrusting traditional office owners into competition with flexible office operators like WeWork, O’Brien says. He notes that shorter lease terms require higher rents to make them economically viable due to higher leasing and capital improvement costs associated with more frequent tenant transition, but competitive pressure limits price point margins.
Office tenants will likely increase their commitment to co-working space in the coming year to provide flexibility from a cost standpoint, O’Brien adds. Employers may take co-working space, for example, when there is a need to accommodate temporary projects, but may enter more traditional leases to meet regular space needs.
Transwestern survey results suggest that the strongest office markets in the coming year will be in the Southeast, Southwest, and Mid-Atlantic regions. More than 75 percent of survey respondents expect new office development to be flat or only slightly higher in 2019 due to concern about oversupply in certain markets and rising construction costs. Norton says that the Mid-Atlantic region is expected to expected to see a notable rise in office construction, primarily due to construction of Amazon’s HQ2 in Crystal City, downtown Arlington, Va.’s business district.