MARKET DRIVERS
Sacramento’s office vacancy rate increased to 11.8% in 1Q24, marking a 40-basis points (bps) quarter-over-quarter (QOQ) rise from 11.4% in 4Q23, and an 80-bps year-over-year (YOY) increase from 11% in the 1Q23. The office market has been significantly affected by the aftermath of the pandemic, leading to increased vacancy rates as more companies reassess their space requirements upon lease expiration, taking into account prevailing economic challenges.
The average asking lease remained steady YOY at $2.18/SF in 1Q24, however there was a 0.5% decrease from $2.19/SF from the previous quarter.
The availability rate rose to 15.3% in 1Q24 from 14.4% in 1Q23 and 14.6% in 4Q23, demonstrating a YOY rise of 90-bps and a QOQ increase of 70-bps. Outside of Class A offices with amenities, tenants are not interested in office spaces, mostly electing to downsize which is flooding the market with product.
Total leasing activity declined by 49.8% YOY, from 1.2M SF in 1Q23, and by 36.4% QOQ, from 486.7K SF in 4Q23 to 626K SF in 1Q24. Despite the overall decline in leasing activity since the pandemic, sublease activity has increased by 13% YOY and 22.7% QOQ. In the current office market, subleases are favored because they offer smaller spaces for shorter terms, which are more suitable for companies still evaluating their space requirements.
Total sales volume for 1Q24 witnessed a 35% decrease YOY from 475.9K SF in 1Q23 and a 68% decrease QOQ from 977.7K SF in 4Q23 to 309.6K SF in 1Q24. Amid shifting market conditions, certain investors are contemplating repurposing office buildings, yet the broader trend of declining office sales since the pandemic reflects evolving real estate dynamics and investor sentiment towards office properties in the current economic landscape.
The direct net absorption reached -468K SF in 1Q24, down from -180.4K SF and 70.1K SF in 4Q23. As tenants’ leases come to term, they continue to reevaluate their space needs in response to evolving work trends, such as work from home policies.
ECONOMIC REVIEW
The unemployment rate in Sacramento County rose to 5.2% this quarter, a 70-bps increase QOQ and a 90-bps increase YOY. In a similar vein, the unemployment rate for California rose from 4.5% in 1Q23 and 5.1% in 4Q23 to 5.3% in 1Q24.
The Professional Business Sector for the Sacramento-Arden-Arcade-Roseville MSA gained 300 jobs from the previous quarter and lost 400 jobs from the previous year. The QOQ increase in jobs is a nice change of pace for the professional Business Sector which has been struggling since the pandemic.
NEAR-TERM OUTLOOK
Smaller banks, which are predominant in commercial real estate lending, are encountering notable hurdles as larger banks reduce their exposure to commercial real estate. Shifting office usage patterns due to remote work and decreased leasing activity have led to high office vacancy rates and declining property values. Coupled with a higher interest rate environment, these factors have contributed to increased loan defaults and delinquencies 1.88in the commercial real estate market. The slow-moving nature of this crisis provides banks with time to adjust their strategies and address challenges arising from nonperforming loans and distressed properties. Some banks are extending maturing loans, while others are selling troubled assets or restructuring portfolios to mitigate losses. The impact of the commercial real estate downturn varies across different asset classes. Experts anticipate a gradual resolution of these challenges over several years as banks navigate through distressed commercial real estate loans and assets.
In recent quarters, the office market experienced a shift towards quality Class A buildings, with a focus on amenities. Post-Covid-19, corporate decisions regarding office locations are increasingly influenced by the appeal of neighborhoods rather than solely the amenities within office buildings. This shift underscores the importance of location over building quality, reflecting employee preferences for vibrant neighborhoods with amenities. The flight-to-quality trend observed in newer, amenity-rich buildings may also indicate a broader movement towards desirable urban neighborhoods.
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