At year-end 2022, the regional office market posted an increase in vacancy going from 10.43% last quarter to 10.52% currently, an increase of 9 bps.
The office market has now seen a rise in vacancy for 10 of the last 12 quarters with a 473 bp upward swing in office vacancy from the 2nd quarter 2019 to the current 4th quarter 2022 vacancy mark. One reason for the surging vacancy is the regional office market continues to post negative net office absorption figures. At year-end 2022, the region experienced negative net absorption of -1.442M+ s.f. which is on the heels of -1.534M+ s.f. in negative net absorption for 2021. The percentage of sublet vacancy also continues to be high at 16%, but is a decline from its peak over a year ago when it topped out at 22%. In the two largest markets, Seattle continues to see vacancy spike with a 20 bp increase in vacancy over the quarter going to 12.99%. The Eastside market continues to post the lowest regional vacancy at 5.56%, although it is up 11 bps from last quarter’s mark of 5.45%. Investment sales continued to slow in the 4th quarter and the amount of new regional construction currently totals 23 major office projects, collectively 70% pre-committed.
Despite strong job growth in 2022, the regional economy faces a number of challenges heading into 2023 especially with regional inflation levels being above national averages. The Fed has further raised target rates by 125 basis points over the 4th quarter pushing them between 4.25% and 4.50% to help tame inflation. At the end of fiscal 2022, per the Puget Sound Economic Forecaster, regional CPI was 8.9% with forecast inflation of 4.9% in 2023, 2.5% in 2024 and 2.0% for 2025. The tech sector (which grew roughly 6.4% in jobs over 2022) has seen recent layoffs, hiring freezes and office closures by some firms leading to a halt in construction for several current construction projects regionally. Total regional employment growth was 5.2% for 2022 per the Economic Forecaster. For 2023 and 2024, job growth is forecast at 0.8% in 2023 and 0.7% in 2024. The region also continues to struggle with staffing shortages heading into 2023.
The regional office market clearly remains unsettled and highly volatile, particularly in Seattle. Looking forward, future office demand remains a big question. Vacancy continues to rise and net absorption has been substantially negative. Early 2023 will be telling as to how changing corporate requirements will dictate work from home/in office policies, office layouts and office employee densities. Indices to monitor are vacancy (including percentage sublease vacancy), net office absorption, inflation and pre-commitment levels for new construction (currently at 70% region wide) as well as future lending policy and underwriting changes.
VACANT SPACE / VACANCY RATE
At year-end 2022, the Puget Sound region has a total office supply of 226.8M+ s.f. For the fourth straight quarter, regional office vacancy has increased. At the end of 4Q 2022, the regional vacancy rate stands at 10.52% compared to 10.43% last quarter and 9.60% one year ago. Regional office vacancy hit a low point in the 2nd quarter 2019 at 5.79% and has generally been on the rise since. In the 2nd quarter 2022, regional vacancy exceeded the 10% mark for the first time since the end of 2013 and it has stayed above the line through year-end 2022. Current vacancy is now 473 bps higher than the ten-year low vacancy mark of 5.79% in 2019. Of the current vacant inventory, 16% is from sublease space which is essentially unchanged from last quarter, but below the 18% mark at year-end 2021. All but one of the five regional market areas saw increases in vacancy over the 4th quarter. The Southend, which currently posts the highest regional vacancy at 15.78% was the only market to decrease in vacancy dropping from 17.15% last quarter, a change of 137 bps. Seattle vacancy increased by 20 bps from 12.79% last quarter to 12.99% currently. The Eastside remains the regional low mark in vacancy at 5.56%, posting a slight increase from last quarter’s mark of 5.45%. Tacoma vacancy jumped to 8.48% from 8.16% last quarter while Northend vacancy is 8.22%, an increase from 7.39% last quarter. The quarterly spike in regional vacancy over the quarter is the result of continued negative net regional absorption, despite the Southend, posting positive net absorption of 413.8K+ s.f. YTD for 2022. This follows negative regional net absorption of -1.53M+ s.f. in 2021 with historically high sublet vacancy levels. The regional availability rate ended 2022 at 14.12%, up from 13.83% last quarter and well above the 11.06% mark from two years ago.
NEW CONSTRUCTION ACTIVITY
At year-end 2022, there are 23 major office projects under construction in the region, all in Seattle and the Eastside. During the 4th quarter, there were no notable deliveries, however seven office projects are scheduled to deliver in 1Q 2023. There were three new office construction starts over the quarter including The Chapter at 230K+ s.f. and 35 Stone at 108K+ s.f. in Seattle, both pre-committed. The Eastside commenced Eight 106 in Bellevue at 440K s.f. Of the regional office projects under construction, nine are in Seattle totaling 1.81M+ s.f. (8% pre-committed) and 14 on the Eastside adding 7.3M s.f. (86% pre-committed). The three largest regional projects remain Amazon committed towers in Bellevue including Vulcan’s 555 Tower (940K s.f.), West Main (1.02M+ s.f.) and Bellevue 600 (999K+ s.f.), although Amazon put the brakes on their occupancy/construction plans for a few projects in Bellevue. Microsoft is nearing completion with their 2.5M s.f. campus office expansion (not shown in the regional construction stats). The construction figures also exclude several large life sciences projects that are underway. Other office projects remain planned in both Seattle and the Eastside, but most developers are hesitant to commence speculative projects until it is known how demand will play out. Collectively for the region, of the 23 office projects underway, 70% of the space is pre-committed.
Four of the five market areas saw decreases in average rent quotes over the 4th quarter 2022. The Eastside, which also posts the highest average rent in the region at $40.29/s.f./yr, saw the average quote increase by $0.80/s.f./yr from the $39.49/s.f./yr last quarter. Seattle, Southend, Northend and Tacoma all saw declines in average rent quotes over the quarter. Seattle dropped slightly from $38.08/s.f./yr last quarter to $37.96/s.f./yr currently, a 0.3% decline. The Southend average rent quote went from $32.80/s.f./yr last quarter to $32.29/s.f./yr while Tacoma dropped from $27.67/s.f./yr last quarter to $27.12/s.f./yr. The Northend decreased to $28.55/s.f./yr from $28.82/s.f./yr last quarter, a change of $0.27/s.f./yr. The rent floor is set by Pierce County at $27.12/s.f./yr. At year-end 2022, the Bellevue CBD has the highest quoted average rent of any submarket at $53.25/s.f./yr. Comparatively, the average rent quote for Seattle CBD is $43.97/s.f./yr. Tacoma CBD is at $26.14/s.f./yr, less than half the current average Bellevue CBD quote.
Similar to last quarter, regional investment sale activity slowed in the 4th quarter of 2022. Although trophy office assets remain in demand, there is reluctance on the part of sellers with few offerings compared to recent history. Many buyers are also taking a wait and see approach to evaluate the market over the next few quarters. While 2021 saw strong regional office investment sale activity, rising interest rates, changing economic metrics and lingering effects of the 2020 REET increase hampered office sale volumes in the second half of 2022. During the 4th quarter, the region saw only 4 office sales closing above the $10 million mark. Of these, two were on the Eastside with one each in both the Southend and Northend markets. The Eastside sales were the transfer of the Abossein Building for $10.3M+ ($981/s.f.) in December and the sale of Belle View Office Park for $28M ($487/s.f.) in October 2022. In the Northend, it was the transfer of Everett Mall Office Park for $14.3M+ ($124/s.f.). The largest 4th quarter sale was in the Southend reflecting the purchase of multiple office buildings in Renton by Children’s Hospital for $84M ($179/s.f.). Although there are few sales to support it, cap rates are pushing upward amidst rising rates. Total office sales volume for the quarter was quite low at $264M+ (among 85 transactions) compared to $406M+ last quarter and compared to a collective $2,976M+ for the first half of 2022.
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