The U.S. office sector continued to recover in the third quarter as leasing volume rose 6.4% year over year amid a steady decline in inventory.

Office markets have generally trended in a positive direction over the past two years, but the pace and strength of the improvement have varied greatly.

According to a report from JLL, gateway markets — defined as large urban areas that act primary as transit points — have experienced the most recent momentum, with leasing up 13% year over year in the third quarter.

Advertisement

Regionally, the Sun Belt has also experienced office sector growth, but at a slower pace than over the past few years. Strong leasing activity was observed in metros areas such as New York, the Bay Area, South Florida, Atlanta, Charlotte, N.C., and Dallas.

These markets have reached about 94% of 2019 leasing levels during the past year and occupancy gains have reached 1.3% of inventory.

Markets locked in the middle stages of recovery include Boston, Houston, Phoenix, Seattle, Austin, Texas, and Orange County, Calif. Those urban areas have reached 85% of last cycle’s 2019 leasing peaks, while leasing absorption has reached 0.6% of inventory in the past year.

Markets in earlier stages of recovery, meanwhile, include Baltimore, Chicago, Denver, Los Angeles, Philadelphia, Oakland, Calif., and Washington, D.C. While net absorption was positive in the second quarter, the overall trend in those markets remains negative for the past 12 months and remain at roughly 66% of last cycle’s leasing peaks.

Office employment meets office demand

Despite the rise in leasing volume, overall office-using employment fell by 6,000 jobs during the third quarter. That followed a modest rise in the second quarter.

Hiring in professional services rose meaningfully, adding 61,000 jobs, however information services lost 37,000 jobs and the finance sector declined by 20,000 jobs. Government employment fell by 10,000 positions.

Thanks to a combination of growth in demand for office space in some cities, though, coupled with reductions in office inventory and a limited pipeline of new product, leasing prices continued to rise.

In fact, JLL predicts that some metropolitan areas may soon be able to support new office construction. New square footage will not be broad-based, however.

“Multiple markets, even lower-priced secondary markets, are showing the potential to support new trophy development when rent-sensitive tenants face extreme supply constraints, but at this stage that activity has not been occurring at the same rate that inventory continues to be removed from the market,” JLL writes.

New construction of office space is so low that it is well below the pace at which buildings are being removed from available inventory.

High-end spaces feeling the squeeze

Just 3.5 million square feet of new office space was completed in the third quarter, matching near-record-low delivery volume seen during the second quarter. But at the same time, about 9.6 million square feet of office space was used for conversions to apartments or redevelopment for other uses.

JLL estimates that office inventory in the U.S. has fallen by more than 45 million square feet from its peak levels of late 2023. Looking ahead, only 24.8 million square feet of office space is in the construction pipeline, a slight decline from the second quarter and pointing to shifting dynamics for office investors in years ahead.

“We continue to expect a [three-plus] year horizon where national office inventory will marginally decline and availability will be extremely compressed for high-end spaces,” the report continued.

In the current market, effective rents for so-called “trophy” and new construction office space have risen more than 20% annually since 2023 as limited supply of high-end spaces drives leasing price increases.

 Second-generation buildings have seen effective rents rise by more than 10% annually as they are beginning to benefit from spillover demand that cannot be fulfilled by the limited supply of Class A buildings or new construction.