Office sector very likely won’t stabilize for quite some time

With the return to the workplace hitting an apparent plateau and a significant percentage of pre-pandemic leases not yet up for renewal, occupancy rates in the office sector of commercial real estate are likely to remain tenuous at best for the near future.

Rochester’s office vacancy rate climbed to 21.9 percent in the third quarter, which ranked 24th highest among 92 total markets surveyed in Cushman & Wakefield’s MarketBeat. As vacancy bumped up a half-percentage point from Q2 (but down 1.4 percent year-over-year), net absorption declined by 114,562 square feet.

The trend isn’t expected to change any time soon, either. Kastle’s national Back to Work Barometer — which measures key fob and keycard swipes at 41,000 businesses across the country — showed that while major employers are pushing a return to office, employee occupancy rate was just 50 percent at the end of October. The percentage of workers in the office was 50.1 to start October.

As a result, employers find it difficult to commit to lease renewals and/or current space.

“It’s going to be a little soft for at least another year,” said John Rogers, real estate salesperson at Cushman & Wakefield/Pyramid Brokerage.

One reason: around half of pre-pandemic office leases still have years remaining, according to Joe Rowley Jr., veteran broker and co-founder of Anchor Real Estate Advisors.

“That means 50 percent of leases still haven’t gone through renewals, and companies are downsizing 30 to 50 percent when they’re signing new leases,” Rowley said on Thursday during a presentation of his annual Rowley Report, an in-depth look at commercial real estate in the Rochester area.

The hardest hit portion of the sector is Class B space. In order to create an environment that appeals to employees, Rogers said, companies are leaving Class B buildings for Class A space, but occupying a smaller footprint.

“To retain their producers and to retain their quality people, they’re relocating to high-quality buildings, high-end space, but taking less square footage,” Rogers said. “The Class B market throughout the country is tough.”

But even with a nicer office available, employees still working under hybrid or work-from-home arrangements aren’t clamoring for a return to the old workday normal, especially when looking at expenses.

Owl Labs, a video conferencing company, determined that 66 percent of the U.S. workforce that has returned to the office spends $51 a day on commuting, parking, lunch and daycare.

“It used to be the owner or manager had the power,” Rowley said. Now, he said, employees can dictate more of the work arrangement, and that power shift continues to influence leasing.

The market, especially nationally, may be further impacted by building financing that is tied to commercial mortgage-backed securities (CMBS).

“Balloons are coming up and it will be difficult to refinance (because of occupancy rates and mortgage rates),” Rowley said. “We’ll be seeing more inventory come onto the market in the next 12 to 18 months, and it’s going to be distressed sales.”

Other markets are facing an even greater problem. According to MarketBeat, third-quarter vacancy rates reached 30.1 percent in Fairfield County, Conn.; 27.1 in San Francisco and 26.3 in Columbus, Ohio.

For CMBS properties, the office delinquency rate climbed 17 basis points to 5.75 percent nationally in October, according to CMBS analytics firm Trepp. By comparison, retail fell 37 basis points to 6.55 in October.

Buffalo and Syracuse are fairing much better than Rochester. The office vacancy rate for Q3 was 17.4 percent in Buffalo, down .4 year-over-year, and 12.8 percent in Syracuse, up .4 year-over-year.

Rochester will get to those numbers, Rogers said, it just will take a little time.

“With a year or two we’ll be closer to 12-14 percent vacancy, especially with Class A,” Rogers said.

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