At the end of the first half 2021, the region continues to see more impacts from the pandemic on the office market starting with the spike in vacancy going from 9.02% last quarter to 9.66% currently. Looking further back, the upward run in the regional office vacancy started in the 1st quarter 2020 when the pandemic first hit.
At that time vacancy was 5.95%. Over the next consecutive five quarters the vacancy rate increased 371 bps to its current mark. This trend of rising vacancy is fueled by several factors in particular the increase in sublease vacancy and negative net absorption. The regional office market is experiencing a continued trend of negative absorption with -521K+ s.f. in the 2nd quarter adding to -2.56M+ s.f. in negative absorption from the 1st quarter of 2021. This is on the heels of 2020’s lowest annual regional net office absorption total in 10 years, at just 50,900 s.f. Sublet vacancy is also very high at 21% of total vacancy inventory. This compares to 11% at the end of 2019. Investment sales volume also remains low despite the five sales over $50M in the 2nd quarter. Balancing rising vacancy and sluggish sale volumes is the healthy level of pre-commitment for the 19 major regional office projects under construction at 77%. This is largely due to the continued demand for close-in office space lead by the likes of Amazon along with Microsoft, Google, Facebook and Apple.
While there has been clear improvement in the job market, until we have fully recovered from the pandemic, the regional office market will remain volatile. Looking forward to the second half of 2021, all eyes will remain on local job growth and the long-term positioning and strategies of companies to either repopulate their offices or continue the Work From Home trend. Economically, since May 2020 when our region bottomed out with employment the region has added 142,700 new jobs (7.2% increase) bringing the total number of regional jobs to 2,119,000 as of May 2021 which still falls about 97,000 jobs below the pre-Covid level. Puget Sound Economic Forecaster’s June 2021 report projects employment growth through the end of 2021 at 2.5%, an increase of 80 bps from their prior estimate. They expect 2022 to be higher at 5.8%. These are encouraging signs especially considering the unemployment rate is expected to dip below the 5.0% mark for the second half of 2021.
While the regional office market remains unsettled, the state has begun to re-open from the pandemic and the region is seeing healthy levels of vaccinated residents. We know the impacts of COVID-19 have brought rising vacancy (particularly sublease), negative net office absorption and sluggish sales and lease volumes which are all evident in the current office market data. However, with expected job growth, healthy employment rates and continued tech demand, the fundamentals are encouraging moving into the second half of 2021.
VACANT SPACE / VACANCY RATE
At mid-year 2021, the region has a total office inventory of 218M+ s.f. Over the last quarter, regional vacancy has continued its upward trend going from 9.02% last quarter to 9.66% currently, an increase of 64 bps. The current regional office vacancy rate is now 196 bps higher than the 7.70% vacancy rate at year-end 2020 and 379 bps higher than the 5.87% rate at the end of 2019. Of the current vacancy inventory, about 21% is sublease space per CoStar, well above the 11% mark at year-end 2019. Four of the five regional market areas posted increases in vacancy over the 2nd quarter with only the Eastside showing decline going from 6.54% last quarter to 6.07% currently. Seattle’s vacancy jumped to 10.95%, an increase of 58 bps over last quarter’s vacancy of 10.37% and a 497 bp hike over the 5.98% rate a year ago. The Southend vacancy sets the high mark for the region at 15.32% with Tacoma at 8.58% and the Northend at 7.72%. The rise in vacancy is the result of a continued trend of negative regional net absorption amounting to -3.08M+ s.f. for the first two quarters of 2021 adding to the -1.46M+ from the 4th quarter 2020. It is also due to surging sublet vacancy inventory in Seattle (2.85M+) and the Eastside (767K+) markets per CoStar. Some independent surveys track these sublease estimates as being much higher. The recent negative net absorption compares to positive absorption of 5.76M+ s.f. in 2019 and 4.45M+ s.f. for 2018. Seattle and the Eastside have posted the largest negative net absorption thus far in 2021 at -1.23M+ s.f. and -770K+ s.f., respectively. The regional availability rate ended the quarter at 12.13%, down slightly from 12.19% last quarter and up from 8.96% a year ago.
NEW CONSTRUCTION ACTIVITY
At the end of the 2nd quarter 2021, there are 19 major office projects under construction in the region, all in Seattle and the Eastside. Over the quarter there were two notable deliveries adding 1.47M+ s.f. of new office inventory to the region’s supply. These include Rainier Square and the Expedia HQ Buildings. Significant new construction starts over the quarter include Washington 1000 (531K+ s.f.) in Seattle and Amazon’s Bellevue 600 (999K+ s.f.) in the Bellevue CBD. Of the regional projects under construction, 7 are in Seattle totaling 2.09M+ s.f. (24% pre-committed) and 12 on the Eastside totaling 5.77M+ s.f. (96% pre-committed). The three largest projects overall are all Amazon towers in Bellevue including Vulcan’s 555 Tower (940K s.f.), West Main (1.02M+ s.f.) and Bellevue 600 (999K+ s.f.). Other proposed office projects loom in both the Eastside and Seattle, but it remains to be seen what will push through. Fortunately for the region, the 19 projects underway are 77% pre-committed.
Of the five market areas, three saw average rent quote declines over the 2nd quarter with two showing nominal increases. The largest increase was the Northend going from $26.86/s.f./yr last quarter to $27.53/s.f./yr currently, a 2.5% bump. Southend rent also increased to $30.30/s.f./yr, an increase of 1.8% over the previous quarter. The biggest decliner was the Eastside going from $41.11/s.f./yr last quarter down to $40.12/s.f./yr currently, a 2.5% drop. Pierce County also saw its average rent quote go down nominally from $26.66/s.f./yr to $26.51/s.f./yr while Seattle lost a penny in the average rent quote from the mark last quarter. The Eastside has the highest average rent in the region at $40.12/s.f./yr, followed closely by Seattle ($39.76/s.f./yr). The rent floor is set by Pierce County at a current rent quote of $26.51/s.f./yr. At mid-year 2021, the Bellevue CBD has the highest quoted average full-service rent of any submarket at $54.53/s.f./yr. The average rent quote for the Seattle CBD is $44.42/s.f./yr with the Tacoma CBD at $26.53/s.f./yr, less than half the Bellevue CBD rate.
Through the first half of 2021 the region has seen a continued trend of lackluster office investment sale activity compared to history. The lasting impact of the 2020 REET increase along with the impact from the pandemic has continued to stymie investment sale volumes with uncertainty remaining among market participants. That said, there has been a steady flow of smaller investment and owner-user office purchases fueled by repositioning among many local businesses. During the 2nd quarter, there were eight sales above the $10 million mark closing in the region. Examples of the more significant transactions in Bellevue included transfers of the Northup Office Center at $22.5M ($535/s.f.), Corporate Campus East at $62M ($554/s.f.) and Spring District’s Block 24 and GIX Buildings at $200M ($1,006/s.f.) and $85M ($859/s.f.), respectively. In Seattle, there were two significant sales including the transfer of 300 Pine for $580M ($753/s.f.) and sale of the newly completed and vacant Boren Office Lofts at $119.1M ($886/s.f.). Reported cap rates remain low. Total office sales volume for the quarter was $1,269M+ (among 124 transactions) compared to $464M last quarter and $2,747.6M in the 4th quarter of 2020.