OFFICE MARKET ASSESSMENT

The District of Columbia’s office market fundamentals showed modest signs of improvement with 24k SF of direct space absorbed in Q2 - its second straight quarter of positive absorption - bringing the YTD total up to 146k SF of occupancy gains.

The District’s direct vacancy rate rose by 40 bps in Q2 and have climbed 130 bps from a year ago to an all-time high of 16.2% largely due to newly delivered space hitting the market.

The Class A sector registered positive absorption for the second straight quarter with 205k SF of direct net absorption in Q2, driven by pre-leased deliveries in the Wharf, bringing the trailing 12-months total up to 690k SF of occupancy gains.

Class B properties continued to experience softness with 192k SF of red ink in Q2 and 1.3 MSF of occupancy losses over the trailing 12 months resulting from recent business contractions and a flight to quality trend that has severely impacted this sector over the past 5 years.

Sublease availability rose by 229k SF to an all-time high of 3.4 MSF in Q2. Nearly 80% of the District’s sublease inventory is located in the East End and CBD submarket with 1.5 MSF and 1.2 MSF of space being marketed, respectively.

Leasing activity modestly slowed during the second quarter, but pent-up demand has caused leasing volume over the trailing 12-month period to improve by 17% Y-O-Y. Leasing volume totaled 1.2 MSF in Q2, up 15.6% compared to its pandemic low a year ago but remains 48% below its pre-pandemic quarterly average.

Although Class A face rates have modestly risen over the past year, the gap between asking and effective rates have widened as owners remain aggressive in pricing, concessions, and flexibility to attract and retain tenants.

The office development pipeline currently has 2.2 MSF of new product under construction currently 63% pre-leased. Developers delivered 994k SF of new product during the first half of 2022, with an additional 1 MSF of new inventory slated to deliver by year-end 2022.

Even though demand remains the strongest for new construction and renovated product, we expect fewer ground breakings over the next 12 months unless a significant pre-lease is secured. Developers have remained cautious in moving forward on any significant speculative projects due to the supply-demand imbalance and uncertainty in the market.

Although the decline in development activity could help stabilize vacancy in the long run, the second-generation spaces that will eventually be left behind as tenants relocate to newer projects will indirectly place further upward pressure on vacancy rates.

The office market will remain tenant-favorable in the near term as space availability options are plentiful, but pent-up activity should help improve leasing fundamentals as return to office momentum continues to build and more companies make long-term real estate decisions. However, we expect office space demand to remain challenged as select tenants consolidate and reduce their footprint to move up in quality and/or adopt a hybrid remote work model.

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OFFICE MARKET ASSESSMENT

After a slow start to 2022, the Atlanta office market registered its strongest quarterly gains since the pandemic’s onset with almost 1.1 MSF of direct net absorption in Q2, improving the trailing 12-months total to 2.1 MSF of occupancy gains. The strong leasing gains which outpaced supply resulted in the market-wide direct vacancy rate declining by 40 bps to 19.7% in Q2 after hitting its highest level since the late 1980s largely due to an influx of construction deliveries.

The Class A sector rebounded with 817k SF of direct net absorption in Q2 after suffering a temporary retraction early in 2022, bringing the trailing 12-months total up to 1.5 MSF. Class B properties also posted 296k SF of occupancy gains in Q2, pushing the trailing 12 months total up to 560k SF.

Noteworthy move-ins contributing to the absorption gains included Google occupying 397k SF at 1105 WP in Midtown, Emory Healthcare moving into 182k SF within the recently redeveloped Northlake Mall, and Insight Global occupying 84k SF at Twelve24.

Sublease availability jumped by 422k SF to an all-time high of 6.5 MSF in Q2. Suburban submarkets currently account for 69% of the sublease inventory with most of the space located in Central Perimeter, North Fulton, and Northwest Atlanta.

Leasing activity has accelerated to 10.6 MSF over the trailing 12 months, up 45.7% since hitting its pandemic low a year ago. Leasing volume totaled 2.7 MSF in Q2, up 49.2% compared to a year ago, but remains 20.9% below the pre-pandemic quarterly average. Tour activity has picked up as occupiers have regained confidence and are more willing to execute on longer-term leasing decisions previously placed on hold due to the pandemic.

The largest lease transactions inked in Q2 included Truist Financial securing a 250k SF pre-lease commitment at 900 SE Battery Avenue, while Transportation Insight signed a 174k SF deal and Insight Global signed a 134k SF deal at Dunwoody’s new Campus 244 project.

New construction remains robust with 4.8 MSF underway, which is currently 33% pre-leased. Approximately 3.7 MSF of new product is scheduled to deliver by year-end, which is expected to push vacancy levels higher until demand begins to consistently outpace supply in 2023.

Rent growth has significantly slowed since the pandemic emerged two years ago but rental rates have trended upwards by 2.2% year-over-year, due to the influx of high-quality new construction delivering to the market on a speculative basis. Rising construction costs and sustained demand for quality space are expected to push rents even higher in the year ahead.

Even though uncertainty has increased, Atlanta’s office market finds itself in an improved position as many companies are returning to the office and several large upcoming corporate expansions and relocations recently announced should continue to bolster the local economic recovery in the year ahead.

The long-term outlook remains positive as metro Atlanta is expected to outperform and recover faster than other major markets as pent-up activity and inbound corporate relocations should translate to stronger leasing momentum and help generate more occupancy in the year ahead.

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