U.S. office absorption fell heavily in Q3 2020 as the effects of the COVID-19 pandemic and recession placed an even greater toll on the market than in the preceding quarter.
National office absorption in the third quarter totaled negative 33.5 million square feet. This is the lowest total in almost 20 years, surpassing the negative 25.9 million square feet seen at the height of the Global Financial Crisis (GFC) in Q1 2009.
Negative absorption over the past six months stands at a cumulative 47.1 million square feet, already more than half of the 92.4 million square feet seen during the GFC which spanned eight quarters. Dependent upon the length and severity of the current economic downturn, this total could be surpassed this time around. Unlike Q2 2020, where losses skewed heavily toward downtown markets, there was an almost equal amount of negative absorption in the suburbs in Q3 2020.
Ten metro office markets posted negative absorption of over one million square feet in the third quarter, led by New York at negative 10 million square feet, of which nine million square feet took place in Manhattan. Other metros with significant losses included Los Angeles (3 million square feet), Boston (2.8 million square feet) and Dallas (2.6 million square feet.)
This decline in occupancy, coupled with the flow of sublease space to the market, is driving up vacancy rates. The U.S. office vacancy rate now stands at 12.6%, an increase of 70 basis points in the third quarter. While this is still comfortably below the record peak of 16.3% seen at the height of the GFC, the third quarter increase is the largest to take place since Q1 2009.
Sublease space is a key contributor to the increase in vacancy. There is now a record 168.8 million square feet of sublease available across the U.S. office market, significantly higher than the prior peak of 143.3 million square feet seen over 10 years’ ago in Q2 2009. Following an increase of 14.5 million square feet in the second quarter, additions of sublease space doubled in Q3 2020 at 29.7 million square feet. There has been a combined 35.5% increase in the volume of sublease space on the market over the past six months taking the national sublease availability rate to 1.5% – the highest on record.
As tenants continue to assess their future space needs, the amount of sublease space on the market is set to continue to rise. On the positive side, for tenants that are active in the market, there is the opportunity to lease well fit-out quality space at a point when lease terms are becoming increasingly negotiable. This comes at a time when we are seeing the first signs of a decrease in rents. Average Class A asking rates in Central Business District (CBD) markets fell by 2.9% in the third quarter, while suburban asking rents held firm.
In summary, the extent and duration of the office downturn is largely dependent upon the continued severity of the pandemic and the development and widespread introduction of an effective vaccine. Once this is in place, the economy and business confidence should improve resulting, albeit with a lag effect, in an uptick in office market fundamentals. The sector looks set to remain challenged through the next 12 months, but we could see signs of stabilization as we move into 2022.