Overview

Opportunities in the Urban Core

Key Takeaways

The office is still a central part of the economy and a driver of productivity, career development, culture and innovation. 

The urban office market faces challenges in 2024, but there are bright spots in activity.
Some of the demographic shifts at the height of the pandemic were temporary, as people still want to live in large, vibrant cities.
Increased remote and hybrid work is shifting occupier demand, and reducing willingness of employees to commute, but much of that impact has already filtered through the system. Portfolio right-sizing will moderate in coming years.
Top-tier office product is very much in demand. There is going to be less new construction delivered, however, opportunities arise for renovated offices and assets slightly further down the value chain.
Occupiers are committed to the office as a part of their business strategy, even if they are offering more employee flexibility than they did five years ago.
Many young employees want to be in the office because it is a place for connection and personal development. To appeal to workers of all ages, the office experience should focus on sustainable practices, superior technology and inviting amenities.
While the office job market has been lagging lately, employment growth will return. As a result, occupiers will need to provide space commensurate with their expanding headcounts.

Opportunities in the Urban Core

Cushman & Wakefield has not been naïve about the current state and future of office in North America. Since 2020, the company has recognized that increased remote work would create sustained impacts on occupier demand and that the nature of office would need to evolve as a result. Cushman & Wakefield also anticipated that some portion of existing office stock would be obsolete, that the glidepath to recovery would take some time and that owners should be realistic about the outlook for 2024.

With all that stated, there are some bright spots within the office market in urban, central business districts (CBDs).

The population out-migration trends in large cities that accelerated early during the pandemic are returning to long-term norms.
The supply-side boom is quickly unwinding, and new office deliveries will be historically low in the middle of this decade.
Occupiers have been right-sizing their portfolios, but much of the effects of increased remote and hybrid work environments have filtered through the system.
Although office employment declined in the second half of 2023, it is still 1.9 million jobs above its pre-pandemic level. Once it resumes growing, look for occupiers to need more office space for their growing workforces.

The Death of Cities Has Been Overstated

The pandemic disproportionately impacted urban cores of cities. Densely populated areas were less attractive for health reasons and because many city centers were less active due to government policy, business closures and consumer behavior changes. This led to a well-documented increase in the net migration out of urban cores, especially in larger North American cities.

Not everyone, however, is leaving New York City or San Francisco to be in South Beach or Boise. In fact, net migration patterns have returned from the 2020-2021 extremes and in some cases look more

promising for large cities than they did prior to the pandemic. For example, net out-migration is now 17% lower in the six U.S. gateway markets than it was in 2019.¹ Additionally, after decreasing for five years, net international immigration into the U.S. nearly tripled in 2022, breaking the 1-million mark for the first time since 2016. Net international migration increased another 48% in 2023, exceeding the 30-year historical average by 23%.² This is an important development because international immigration is a key driver of population growth in large North American cities.

¹ Cushman & Wakefield Research analysis of U.S. Postal Service (USPS) Change of Address data
² U.S. Census Bureau; Moody’s Analytics Estimated

MONTHLY NET MIGRATION IN U.S. GATEWAY MARKETS

After an exodus in 2020, population trends have returned in U.S. gateway markets

Source: Cushman & Wakefield Research analysis of U.S. Postal Service (USPS) Change of Address data

All of this points to a recovering population trend in and around large North American cities. The urban core continues to be attractive to people looking for economic opportunity and vibrant, diverse places to live. Residents have flocked back to the cities. Multifamily absorption as a share of inventory has been double that of the suburbs over the past four years (16.4% vs. 8.7%).³ National U.S. multifamily vacancy in the CBD is currently lower than in the suburbs, which has not occurred since 2012. Cities are still places where people want to live, creating opportunity for more conversions of office space to housing over the next decade.

³ CoStar

U.S. MULTIFAMILY VACANCY RATE, CBD VS. SUBURBS

Urban multifamily vacancy is lower than in the suburbs for first time since 2012

Source: CoStar; Cushman & Wakefield Research

Occupier interest in CBD office submarkets has boomeranged slightly over the past four years. In 2019, 41.7% of Class A office leasing occurred in the CBD. That proportion dropped to 37.2% in 2021 before improving to 38.7% in 2023. Office vacancy has increased more steeply in CBDs than the suburbs, but some of that has been driven by supply-side dynamics. Nearly half (46.1%) of office deliveries over the past two years have been in the urban core even though the CBD historically only accounts for approximately one-third of total office inventory.

Even with supply-side challenges, CBD vacancy is still lower than suburban vacancy in 40% of U.S. markets. In a hybrid work environment, many occupiers continue to look at centralized, urban office locations as the best option for their workforce.

New Supply Will Slow Over the Next Few Years

Office construction activity had been gathering steam in the latter years of the last decade, and by early 2020, the under-construction pipeline was at historically high levels. New office deliveries over the past four years have been a significant contributor to growing vacancies, with 185 million square feet (msf) of office deliveries since the beginning of 2020 (representing 3.0% of U.S. inventory and 5.4% of Canadian inventory) plus another 23 msf of completed office renovations that increased inventory.

However, due to rising construction costs, labor challenges and high interest rates, the new construction pipeline is shrinking for commercial property types, including industrial, multifamily and office. Now the new office construction pipeline is at less than half of its 2020 peak, and is equal to 1.1% of current inventory, down from 2.5% in 2020 and below the pre-pandemic norm of 1.5%.

CBD SHARE OF NEW CONSTRUCTION, 4-QTR. ROLLING

Office deliveries in CBD have been elevated since 2018

Source: Cushman & Wakefield Research

Construction activity has been occurring disproportionately in the urban core. At the beginning of 2020, the CBD construction pipeline was 3.9% of existing inventory, while in the suburbs the equivalent of 2.0% of inventory was under construction. In CBDs, 4.1% of current inventory is comprised of space delivered over the last four years while outside of urban cores, just 3% is. This elevated construction activity creates opportunities for occupiers looking for the best office product, but it has also put upward pressure on CBD vacancy rates as new construction has accounted for over 40% of the increase in vacancy over the past four years.

Office construction activity is slowing and will continue to moderate through the middle of the decade. In fact, over the next four years, the North American office market is forecast to deliver just over one-third of the space that came online since 2020 (66 msf vs. 185 msf).

PACE OF NEW OFFICE DELIVERIES TO PLUMMET

Total square footage of office deliveries in U.S. & Canada by year

Source: Cushman & Wakefield Research

The effects of this are twofold. First, occupiers will have fewer options for leases in the newest and best spaces since there will be less new construction. Second, owners will have an opportunity to fill in the high-quality office market by renovating and upgrading existing space over the next few years. Not surprisingly, the amount of office buildings undergoing significant investment and renovation has doubled since 2019.

Occupiers Are Still Committed to the
Right Type of Office

Although the amount of remote work is structurally higher than it was in 2019, the majority of companies are moving forward with hybrid workplace strategies that have employees splitting time between being in the office several days a week and working remotely. The net impact of hybrid work policies on space needs is much smaller than when employees shift to 100% remote work, and fully remote workplace strategies continue to be an outlier among North American companies.

There is reason to believe that much of the impacts of increased hybrid and remote work have worked their way through the system. Organizations with stated workplace policies are still leaning heavily on hybrid work ecosystems, with 50% of the firms tracked by Cushman & Wakefield Research currently utilizing a hybrid structure. However, that is down from 58% in 2022, and the share of companies with an office-centric (i.e., 3+ days per week in the office) workplace policy has increased from 19% to 35%.

As companies change their policies, they almost always shift towards more in-office work, not less. In fact, over one-third of firms that were “remote-first” in 2022 have shifted to either hybrid (25%) or office-centric (11%) policies. One-fourth of organizations that were hybrid in 2022 have shifted to be office-centric over the past two years. All of this points to the fact that companies may be past “peak remote” work, as most occupiers are focused on how they optimize in-office attendance along with employee flexibility to maximize productivity, career development, innovation, culture and employee engagement.

COMPANIES SHIFTING TOWARDS MORE
IN-OFFICE WORK

Share of companies with each workplace strategy in 2022 and 2024

Source: Cushman & Wakefield Research

According to a current survey being conducted in partnership between CoreNet Global and Cushman & Wakefield, office occupiers expect to shrink their overall office portfolios by just under 3% on average in 2024. This magnitude of tenant downsizing countered by new entrants to the leasing market lines up with our U.S. Macro Outlook published in December in which our base case scenario calls for an increase of vacancy of approximately 160 basis points (bps) this year before national vacancy declines in 2025. When economic uncertainty fades and office job growth picks up again, expect occupancy to stabilize and absorption to turn positive.

Cushman & Wakefield is already seeing some positive glimpses in the data. In 2023, 44% of renewals over 15,000 sf were expansions—that is, occupiers renewed in place and increased their square footage in the building. One-third of renewals were completed with the exact same amount of space, leaving less than one-fourth of office renewals that were signed for less space this past year. The local market sections of this report highlight some of the most significant occupier expansions that occurred in the past two years—instances where tenants are doubling down on the office in key urban corridors of North America’s largest cities.

Overall gross asking rents at top-tier assets are 51.5% higher than the rest of the office space in gateway markets. Vacancy rates in North American top-tier office assets (excluding lease ups) are 530 bps lower.

Of course, this demand is not equally shared across office product. The real winners over the past four years have been offices that are newly constructed, recently renovated and/or offer the latest in amenities for its occupants. This top-tier office space, however, only accounts for 10%-15% of total inventory. While small, this section of the market is clearly outperforming. Vacancy rates in North American top-tier office assets (excluding lease ups) are 530 bps lower. Quality matters even more in large cities; vacancy in top-tier office properties in gateway markets is 700 bps lower than the rest of the market.

CBD VACANCY SIGNIFICANTLY LOWER IN TOP TIER ASSETS

Top tier vacancy vs. reset of office market for select markets, bps difference

Source: Cushman & Wakefield Research

The Office Economy Will Recover

Job growth numbers surprised to the upside throughout 2023, but this masks the fact that U.S. office-using employment declined by nearly 90,000 jobs in the second half of the year. Employment gains in late 2023 were concentrated in other sectors, many of which were slower to recover from the effects of the pandemic: leisure and hospitality, government, education and healthcare, for example.⁴ Office employment is already in a recession.

Even when office-using employment was experiencing strong growth (approximately
3 million office jobs were added in 2021 and 2022), the relationship between employment and office demand had been dislocated.

In other words, even with positive job creation, tenants were not increasing the square footage of their occupancy, as they right-sized portfolios and adjusted to new hybrid paradigms of work. This negative correlation will not last forever.

Cushman & Wakefield forecasts that after a moderate recession in 2024, office employment in the U.S. and Canada will recover in 2025, ending next year with approximately 2.5 million more office workers than at the end of 2019. Lower interest rates than today will help the housing and financial services sectors recover, while artificial intelligence will supplement employment for North American technology firms.

Another 1.8 million office jobs will be created in the second half of the decade, and tenants will find themselves needing more office space to support their teams. In fact, the Cushman & Wakefield Macro Outlook forecasts 67 msf of positive absorption in the U.S. and Canada between 2025 and 2027. Urban cores have a higher share of office-using employment. Housing density, walkability, public transit access and highly amenitized neighborhoods will continue to drive agglomeration effects, attracting college-educated residents, young employees and office workers.

⁴ U.S. Bureau of Labor Statistics

Research Contacts

David Smith
Head of Americas Insights
Global Research
david.smith4@cushwake.com

Richard Persichetti
Americas Markets Research Leader
richard.persichetti@cushwake.com

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