The numbers are in. As anticipated, the U.S. office market saw a downturn in Q2 2020. During the first quarterly period fully impacted by the COVID-19 pandemic, net absorption totaled negative 13.6 million square feet. This was the first negative quarterly absorption total in over 10 years, with the last occurring in Q1 2010.

An additional 10.3 million square feet of new office space was delivered in the second quarter, resulting in a 24 million square feet delta between supply and demand. This drove the U.S. office vacancy rate up by 30 basis points to 11.8%.

Downtown markets were the hardest hit posting a combined 9.5 million square feet of negative net absorption, compared with negative 4.1 million square feet in the suburbs. Downtown office vacancy rose by 60 basis points in Q2 2020 to 10.8%. The impact on suburban markets was less pronounced, with vacancy rising by 20 basis points to 12.4%.

This shift in fundamentals was particularly evident in the six gateway metros – Boston, Chicago, Los Angeles, New York, San Francisco and Washington D.C. – which combined for negative 9.8 million square feet of net absorption. The San Francisco Bay Area (Bay Area) was the hardest hit with net absorption totaling negative 4.6 million square feet, over half of which occurred in downtown San Francisco. The San Francisco Peninsula was also hit hard with just under one million square feet of negative absorption.

Two other metros from the top six also saw over one million square feet of negative absorption: Boston with negative 1.2 million square feet and New York with negative 2.6 million square feet. These occupancy losses were concentrated in the core urban areas of Boston’s central business district (CBD) and Manhattan. Washington D.C. was the only leading market to emerge unscathed in the second quarter, posting just over 200,000 square feet of positive absorption. The dominant presence of government in Washington D.C.’s tenant profile serves to lessen the impact of cyclical downturns.

The vacancy profile across the core areas of the six markets has shifted accordingly. San Francisco, which had the lowest vacancy rate in the nation, saw vacancy rise by 240 basis points in Q2 2020 to 7.7%. Boston and Chicago also witnessed triple-digit increases of 200 and 120 basis points respectively. Manhattan now has the lowest vacancy rate among the top six, at 5.9%, while Washington D.C., which has seen a surfeit of new supply in recent years, remains the highest at 15.1%.

Where to Next?

With businesses taking a very tentative approach to returning to the workplace, the impact on office sector metrics will take some time to fully emerge. While we have seen the first evidence of a downturn in Q2 2020, the true test will be the second half of the year. It may take several months, and multiple phases of reopening, before firms can fully assess their space needs.

What are the prospects for office demand? The depth and length of the coronavirus recession will be a key determinant, as will future patterns and levels of occupancy. To what extent could firms downsize their footprints, particularly in downtown locations, and what share of jobs will shift to being permanently home-based?

Turning to history for any precedent, there was a cumulative 92.4 million square feet of negative office absorption in the U.S. during the Global Financial Crisis (GFC) and the vacancy rate increased from 12.3% to 16%. In addition, an additional 189 million square feet of new supply was added during this period, further exacerbating the downturn.

With decision marking largely on hold, we have yet to witness any significant decline in rents as transactional evidence is limited at best. Look for rents to find a new ceiling once a clearer picture in occupancy levels emerges.

Should there be a major flow of sublease space onto the market, this space should be competitively priced, creating the potential for rents to drop as landlords seek to compete. Expect any decline in rates to be more prevalent in older, commodity space. Where face rates do hold up, this will likely be due to increased incentives on offer, thereby lowering net effective rents. Putting these prospects into historic context, average Class A asking CBD rents fell by 25.2% during the GFC. Suburban rates were also impacted, but by a much lower 9.5%.

In summary, we are in challenging and uncertain times. The longer the pandemic lingers, the greater the likelihood that many of the required behavioral changes that were perceived to be temporary, such as social distancing, online meetings and working from home, will become more entrenched into the culture of the office.  Similarly, the longer the pandemic, the greater the likelihood that firms will implement more longer-lasting changes in their occupational portfolio, and we expect to see notable variations in performance from market to market.

In order to adapt and succeed, the office sector must further embrace two key concepts: flexibility and choice. Tenants appear to be moving toward a more geographically diverse premises strategy coupled with a desire for more flexible lease terms. In recent years, providing the best workplace experience to attract and retain talent has become as critical a decision-making reason for property selection as location. Going forward, providing employees with choice in where, and how, they work, while seeking to provide the optimum experience, will become even more important.