Despite substantial challenges, the office market shows several green shoots of opportunity and promise for brighter days ahead. Beneath dire predictions, there’s a renewed sense of improvement. Kidder Mathews office experts reveal both optimism and stark realities across six key Western U.S. markets.
We will examine performance, activity, conditions, and future prospects to understand how these office markets are being reshaped and where growth is expected. Emerging trends include well-timed buy or lease opportunities and new workplace settings resembling hotels or homes.
Transformation in the Pacific Northwest
Starting in the Pacific Northwest, the Seattle office market, one of the nation’s hardest-hit, exemplifies the transformation underway. Companies are gaining a better grasp of space needs post-pandemic, as new return-to-work and hybrid work practices take firm shape.
David Gurry, an EVP in Kidder Mathews’ Seattle office, notes an uptick in downtown Seattle activity. “Deal velocity is increasing despite the pandemic’s impacts,” says Gurry, citing negative absorption from downsizing. He identifies key factors driving Seattle’s office market recovery.
Firstly, companies are seizing the favorable tenants’ market to secure long-term leases. “It’s prudent to execute a long-term lease now,” explains Gurry. Secondly, technology firms are returning to offices, driving demand for “rent-ready space,” and well-priced office assets are trading quickly. “Now is probably the best time to cut a deal in the last 25 years, especially for higher-quality spaces,” notes Gurry. However, Class B buildings are proving tougher to move.
Gurry highlights a shift from remote hiring to local hiring. Companies are creating office settings that rival home comforts to pull employees back. “Offices are set up much differently today,” he says, with casual breakout areas, lounge seating, TVs, and other amenities. “Some tenants even have kegerators to make the office as comfortable as home.”
Many businesses are also setting firmer expectations for in-office days, increasing office demand in Seattle. “Companies have decided they need an office and now know their footprint. While this increased activity isn’t reducing our vacancy rate yet, it’s creating a level of activity we haven’t seen in a while in Seattle,” says Gurry.
Kidder Mathews’ Rod Keefe, an SVP in Seattle, notes that lease rates continue to drop, and vacancies are expected to increase throughout the year. Despite an uptick in volume and activity, levels are still below pre-pandemic numbers. “Tenants right-sizing and shrinking their office footprints, driving rates down by 10% to 30%,” says Keefe. “Tenant improvement allowances are up 20% to 30% and free rent has doubled, if not more.”
Washington’s low return-to-work percentage is hindering the Seattle office market. However, many companies remain profitable even with remote working practices. Tenants are downsizing but are moving to higher-quality buildings where landlords can achieve higher rates. Keefe estimates a full recovery is still three to five years away.
There is a flight to quality underway in Bellevue, notes Gary Guenther, an EVP in the firm’s Bellevue office, spurred by the rise of work-from-home and hybrid practices. The city’s direct vacancy is 10%, sublease vacancy has risen to 26%, and there are 135 full floors available in the CBD, partly due to Microsoft consolidating from downtown Bellevue to its Redmond headquarters.
“Sales activity in Bellevue has plummeted,” says Guenther. “There is a lot of capital on the sidelines, but there’s also a large bid/ask gap.” Office landlords face refinancing and capital call challenges, making it harder to perform on lease transactions. Guenther advises tenants to consider landlord stability, as some may struggle to fulfill lease obligations, while financially stable landlords are better positioned to perform TI and capital improvements to retain growing tenants.
Similar to downtown Seattle, Bellevue tenants are creating their own common areas in their space layouts. “They seek to foster collaboration, achieving this via rest/retreat locations with a residential or hospitality feel,” says Guenther. “As a result, Class A landlords can hold rental rates, though we’re seeing more TI’s and concessions.” The Bellevue market is driven by large tech and AI firms leveraging existing tech infrastructure and talent. “Companies see Bellevue as safer, cleaner, and more business-friendly than Seattle,” notes Guenther.
The appetite for suburban product continues to grow as companies adapt to employees’ priorities. In the South Sound, a largely suburban market, leasing velocity is increasing with transaction volume returning to peak levels not seen since 2018–2022.
Will Frame, an EVP in Tacoma, notes that rental rates have risen as demand for Class A space has increased. “The success of the market will be dictated by the amount of space that is ‘given back’ to the market over the next several months,” he says. “Absorption would be comparable to pre-pandemic levels; however, we continue to see tenants downsizing or exiting entirely from their physical locations. The suburban markets have seen far fewer changes, resulting in nearly flat absorption, while urban cores have been in a state of negative absorption.”
Companies continue to expand into the South Sound as they open “satellite” offices for employees. This helps reduce travel time, recruit and retain talent, provide an appealing cost of living, and plant a flag in a new market. The trend has influenced a variety of changes in the leasing market, including rent increasing at a greater rate than the expected 3% or so annually. “Now, we are seeing 5%–10% increases across all classes,” says Frame.
The pandemic has left a lasting impact on a tenant’s thought process, most notably impacting tenant improvement allowances, which have continued to increase with many transactions becoming “turnkey.” “Given the increased demand for turnkey transactions, we are seeing most lease terms between 7–10 years,” notes Frame. “A five-year lease is no longer the standard.”
Meanwhile, he says, “Today’s net effective rent is similar to 2018–2019. However, the path to a signed lease is far different now than five years ago.”
The entire country has seen a significant slowdown in sales transactions, most notably due to the current interest rate environment. Frame predicts this trend will continue through the end of 2024, with an increase in value-add investment sale volume. “The highlight of the sales market has been the owner/user transactions that are of a manageable size and price,” he says.
Market Drivers in Northern California
Moving into Northern California, Kidder Mathews’ Jeff Ramirez, an SVP at the firm’s San Jose office, notes that the San Jose/Silicon Valley office market is experiencing shorter lease terms, more flexibility, and higher build-out allowances. Although lender limitations may create issues with meeting some tenant concessions, they are also seeing free rent, reduced rents, and additional amenities being added to offices. While vacancy rates are increasing and concessions are evident in the market, it is presenting interesting backfill opportunities. Tech is driving deals, including electric vehicle and artificial intelligence startup firms, as well as technology giants, life science companies, and biotech firms. “An interesting facet of the San Jose/Silicon Valley office market is the emergence of ‘remote first’ companies,” says Ramirez. “We are also seeing legal, financial services, and consulting firms upgrade to higher-quality workplaces.”
The Silicon Valley office market is characterized by a variety of incentives and amenities designed to attract a diverse range of tenants amidst increased vacancies and shifting work models. According to Ramirez, good deals are available as landlords are motivated to secure leases in a competitive market. The types of tenants driving these deals include tech companies, life science firms, remote-first organizations, and professional service providers, each with specific needs and preferences shaping their leasing decisions.
According to Sandy Rodriguez, an AVP in the Kidder Mathews’ San Jose office, the Peninsula office market is “sluggish.” Professional services firms and medical tenants are driving the market, focusing on a flight-to-value strategy. Small tenants are active, seeking to uncover value. Meanwhile, larger tenants are seeking space early but are slow to move, looking for quality and amenities including on-site conference facilities, fitness centers, pleasant outdoor spaces, on-site or nearby food options, and ample, easily accessible parking.
“The key to completing leases,” notes Rodriguez, “is patience and working to meet the tenant’s needs in terms of economics and/or improvements. Tenants can negotiate favorable terms.”
Record Concessions for Greater Los Angeles
Lastly, moving further down the California coast, Kidder Mathews’ John Anthony, an EVP in Los Angeles, notes that the Downtown Los Angeles market has largely become a buyer’s and tenant’s market. Few companies are exploring lease space, and the competition for existing tenants is fierce, Anthony observes.
This has created a market where owner-users are in strong positions to acquire assets at a lower basis. Office tenants in the urban core are downsizing and, in some cases, relocating to suburban office markets. “Downtown Los Angeles is a market where good deals are plentiful for both owners and tenants,” says Anthony. “We’re seeing a record level of concessions, with both landlords and sellers taking aggressive approaches.”
What is the Outlook for the Office Sector?
The office sector has several common threads woven throughout its future. As noted by Kidder Mathews’ office market experts, opportunities range from companies seeking higher-quality spaces and redefining them to appeal to employees, to capturing value in a declining market. The transformation across the office sector will continue now that companies better understand their space needs and employees return to work to collaborate, connect, and contribute to company growth and their career success.
Contact
| BRIAN HATCHER President & COO brian.hatcher@kidder.com View Bio |
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