MARKET DRIVERS
Sacramento’s office vacancy rate fell to 11.6% in 3Q24, marking a 20-basis points (bps) quarterover-quarter (QOQ) increase. In the wake of the pandemic, many companies continue to re-evaluate their office space needs as leases expire. This, combined with current economic issues, is driving vacancy rates up in the office market.
The average asking lease remained steady QOQ at $2.19/SF in 3Q24, which is up from $2.18/SF since 3Q23.
The availability rate rose to 15.5% in 3Q24, demonstrating a YOY rise of 50-bps and a QOQ increase of 20-bps. Demand has shifted away from standard office space, with tenants in non-Class A buildings downsizing. This downsizing is creating a surplus of vacant office space. Total leasing activity declined by 15.0% for the first three quarters of 2024 versus those of 2023, about future space needs is driving demand for subleases and shorter-term direct deals. These temporary arrangements offer smaller footprints and flexible terms, allowing companies to adapt as they re-evaluate their office requirements. Even with these factors, subleases have seen a decline YOY and QOQ.
Sales volume for 2024 has so far lagged 2023, trailing by 15.1% 1,526,939 SF of product sold cumulatively this year. This quarters figure of 399,791 SF was nearly a doubling of last quarters 230.1K SF, though total sales volume was down over $30,000,000. Recent sales volume has drawn attention to the slowdown in the investment market in the office sector with six of the past seven quarters have posted less than $100,000,000 in sales volume, something that has only occurred eleven times in the past decade. These trends point to the softening investment sales market, something that is doubly effected by recent economic insecurity. A rate cut of 50 basis points in September and a further pledged cut in November look likely to stimulate activity, but the degree of these effects is yet to be seen.
The direct net absorption reached 14,434 SF in 3Q24, down significantly from 1.3M SF in 2Q24. Deliveries have hit a 10-year high of 1.5 million SF with a quarter to spare. This unprecedented level of deliveries will not affect net absorption because the entirety of the square footage is attributable to the May Lee State Office Complex which will be occupied by seven state agencies.
ECONOMIC REVIEW
Unemployment rates in Sacramento County rose by 50-bps over the past year. Meanwhile, the number of unemployed is greater than at any time since October of 2021, signaling the comparative weakening of the local economy.
NEAR-TERM OUTLOOK
Moving forward, work from home trends and associated depressed office utilization rates versus pre-pandemic numbers has seemed to solidify over the course of the past two years. While many firms with pressing needs to downsize have already subleased their spaces, many continue to wait for their lease terms to expire before rightsizing, providing a reliable stream of new vacancies for several years to come.
Coupled with this, inflationary pressures, the cost-of-living crisis, and the federal reserves resolve to keep rates elevated has resulted in a sluggish economy and labor market – all of which may bode negatively for tenant demand. All this said, inflation has returned to only moderately above the federal reserves long term target allowing an aggressive rate cut of 50 basis points to occur in September. This cut will make financing easier thereby boosting the economy and making taking new investments a more enticing opportunity. This said, many investors are already benefitting from leverage at the near zero rates of 2020 and 2021, thus disincentivizing them from reworking their loans. This coupled with a “soft” approach to further rate cuts professed by Federal Reserve Chair Jerome Powell points to a slow recovery to investor sentiment.
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