Eye of the Storm – Dec. 9, 2024
The U.S. office sector had a strong third quarter of leasing activity. In 30 of the 60 markets tracked by Newmark, Q3 saw net absorption gains compared to the trailing 12-month average. The firm also reported last month that office-using employment has grown over the past six months in 35 of the top 50 markets.
Last week, Moody’s CRE provided its take on the sector’s outlook, noting that the vacancy rate ticked downward “ever so slightly” by 10 basis points to a nationwide average of 20%. “Despite this, we should not necessarily expect it to monotonically increase going forward with our baseline forecast predicting a peak in late 2025/early 2026,” wrote Moody’s CRE economist Nick Villa.
In this longer-term context, Q3’s marginal improvement might be likened to the eye of a hurricane: an interval of relatively calm weather that soon gives way to a return of dangerous winds and storm surges. Villa warned that “the path ahead will be non-linear,” noting that the slight compression in national vacancies was likely due to net absorption turning positive for the first time in seven quarters.
“Even so, as we enter 2025 with a more favorable macroeconomic backdrop, we’re already starting to see signs from the capital markets that we’re nearing a bottom,” wrote Villa. “That said, there’s still a lot of geopolitical uncertainty, especially with a new administration and Congress, so we likely won’t definitively know we reached a bottom until after it has passed.”
He pointed out that previous research from Moody’s CRE has shown that increased employee office visits don’t necessarily translate into higher office occupancy rates. However, wrote Villa, “one interesting dynamic to watch with the new administration will be a potential federal RTO [return to office] mandate, and the impact it could have not only on the sector but also on downtown economic growth across the country, particularly given that the General Services Administration (GSA) leases over 363 million square feet of office space.”
Regarding GSA office occupancy, the incoming administration is sending mixed signals. On the one hand, there’s the prospect of an RTO mandate. On the other hand, Elon Musk and Vivek Ramaswamy have proposed, via their Department of Government Efficiency initiative, to cut as much as $2 trillion from federal spending.
Musk has been quoted as saying the current roster of 400 federal agencies could be pared back to 99. Assuming that it can be carried out on the scale proposed by Musk, this reduction in headcount would almost certainly mean a massive reduction in federal office space requirements.
The impact of such a reduction wouldn’t be uniform across the U.S. Naturally, the Washington, DC metro area would likely be hardest hit, since the GSA leases more than one-third of the metro’s office space. Other metro areas that are home to regional offices of federal agencies would also be affected to varying degrees.
This brings the discussion back to the undeniable truth that real estate remains a regional business, regardless of national trends. Villa wrote that “while a 20% vacancy rate is the current benchmark across the United States, there are, of course, several metros whose Central Business Districts (CBDs) well exceed this level.”
Moreover, Villa’s analysis shows that CBD vacancies aren’t always in lockstep with vacancies in the broader metro areas. The Tucson, AZ CBD has strongly outperformed the metro area in post-pandemic recovery, while in San Antonio, TX it’s just the opposite. These local-level variations in performance will persist with or without large-scale cutbacks in federal office use.