In the aftermath of the COVID-19 pandemic, the commercial office market has faced a tumultuous recovery. However, amid the uncertainty, new office construction has shown some signs of resilience. Yet, even this sector, which was once seen as a bright spot, is now presenting unexpected challenges for investors. As development slows to a historical low and tenants grow more selective, understanding where demand for office space lies has never been more critical.
The Shifting Landscape of Office Demand
The interest rate hikes that began in early 2022 significantly impacted the financing of new office developments. Coupled with stagnant demand and continued high interest rates, new construction has taken a hit. Over the past few years, the amount of office space in buildings less than four years old has dropped by more than 50 million square feet. While one might expect this scarcity of new space to spark higher demand, the reality tells a different story.
Despite fewer new buildings coming online, the availability of space within the newest buildings remains virtually unchanged. The availability rate for new constructions has soared above 23%, a level unseen since the Great Recession. Investors are now facing the reality that not all new office spaces are equally desirable. The question becomes: Where is the demand, and how can investors strategically navigate this landscape?
The Granularity of Demand
As of today, approximately a third of all space in new, multi-tenant office buildings larger than 100,000 square feet remains available. Even more telling, nearly a third of these buildings are less than 50% leased. While this statistic may seem bleak, it highlights the crucial factor for investors to consider: demand is highly segmented, even within the same market.
For example, in major markets like San Diego, Denver, and Los Angeles, the levels of available space in new office buildings are significantly higher than the national average. But here’s the nuance—within these markets, demand varies by location, and prime submarkets are still performing exceptionally well.
In Denver, the Cherry Creek neighborhood is one such example, where office buildings are filling quickly, leaving limited availability. Similarly, Bellevue, a submarket outside Seattle, continues to attract strong tenant interest. These locations offer a key insight: investors should focus on where the demand is concentrated within a market, rather than assuming that new buildings across an entire city will perform equally well.
Key Factors Shaping Tenant Decisions
Location within a market is just one piece of the puzzle. A building's proximity to transit, access to parking, and nearby amenities are all critical factors influencing tenant demand. The ease with which employees can access the office and the lifestyle features available nearby have become essential in a hybrid work environment where office attendance is more intentional than before the pandemic.
Additionally, rising construction costs have forced developers to increase rents in new buildings to achieve a return on investment. While tenants previously sought premium spaces without much regard for higher rents, the tide is now turning. Large office occupiers have become increasingly sensitive to rent costs, particularly in an environment where many companies have slowed or stopped hiring.
A New Tenant Mindset: Opting to Renew
A growing trend among office occupiers is opting to renew their existing leases rather than move into newer, more expensive buildings. This decision allows businesses to avoid the premium rents that come with new construction and the logistical and financial burdens of relocating. Moving offices often involves paying higher rents and investing in new furniture, equipment, and potentially expensive fit-outs to customize the space.
For investors, this trend highlights an opportunity to focus on properties with tenants approaching renewal. With many businesses choosing stability and cost savings over flashy new spaces, these “renewal in place” strategies offer a more conservative yet reliable source of income in a volatile market.
Finding Opportunity in a Conservative Market
With many companies adopting a wait-and-see approach as they navigate economic uncertainty, it’s clear that large commitments to new, premium office spaces have become a tougher sell. The long-term nature of office leases—often stretching a decade or more—makes businesses wary of committing to spaces without full confidence in both the building and its location.
This means that for investors, the key is not just to follow new construction but to understand the nuances of specific submarkets deeply. Areas with high demand for new office spaces, like Cherry Creek and Bellevue, will likely continue to perform well, making them attractive investment targets. Meanwhile, central business districts in the same cities might struggle to attract tenants, signaling higher vacancy risks.
Markets to Watch
Some markets are outperforming others when it comes to new office building demand. In addition to Denver’s Cherry Creek and Bellevue near Seattle, cities like Charlotte and Philadelphia have maintained relatively low new-building availability. Still, even in these stronger markets, over a third of large new office buildings are less than 50% leased, reinforcing the importance of location within the city.
For investors seeking opportunities in a challenging office market, the best approach is to prioritize prime locations within strong markets. Look for submarkets with high tenant demand, where proximity to transit, amenities, and lower vacancy rates drive occupancy. The next step is to assess buildings with tenants nearing lease expiration, as these occupiers may prefer to renew rather than face the higher costs of moving into new office spaces.
The Path Forward
Demand will remain granular and uneven as the office market continues its slow recovery. Investors must stay ahead of these trends by focusing on submarkets with proven tenant interest, watching for signs of renewal opportunities, and carefully evaluating the costs associated with new construction. While the overall market may face headwinds, there are still pockets of opportunity for those willing to dig deeper into the data and understand the shifting patterns of office space demand.
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