Commercial Real Estate Outlook: Trends Influencing Office Space Mid-2023

In this article, you'll learn:

• How decarbonization efforts are reshaping office space compliance.
• The impact of rising vacancy rates on office leasing strategies.
• The potential challenges of converting empty offices into housing.
• Why demand for premium office buildings is rising in a competitive market.

Understanding trends as they develop is crucial for businesses and real estate professionals to navigate the ever-changing landscape of office space. Because, the dynamics of office space are constantly evolving, shaped by various trends and forces in the business world.

So let's take a mid-year look into the main disruptive forces shaping the office market forecast. 

Decarbonization

The latter half of 2023 is definitively marked by a growing emphasis on the decarbonization of office spaces. This is also part of the greater Environmental, Social, Governance (ESG) movement. And as companies become ESG compliant, real estate is taking a center stage. Because commercial real estate is one of the biggest energy consumers as well as the culprit behind 31% of greenhouse gas emissions, more than any other leg of the economy.

Since transforming major CBDs to carbon-neutral entities is such a big task, governments are levying hard, fast, and expensive ramifications so businesses don’t drag their feet in the transition. Extreme fines are putting fire under the feet of corporations (where the boiler used to be) to adapt or die… and these fines are starting in 2024. So, you better believe that the latter half of 2023 will see a lot of scrambling for compliance.

New York, for example, is poised to enforce fines totaling $200 million on approximately 3,700 properties that do not meet code, according to a study conducted by Level Infrastructure on behalf of the Real Estate Board of New York. The New York Climate Mobilization Act, passed in 2019, has finally reached its reckoning hour. Properties that exceed the limits are set to face fines of $268 per metric ton over the limit starting in 2024 with stricter standards plotted to begin in 2030. Read more about New York's Local 97 Law and Whether it's Realistic. 

This will also drastically devalue space that operates on outdated energy systems. Because fines unleashed on landlords may trickle down to the tenants in non-compliant buildings if they don’t have safeguards in their lease.

Commercial Tenants: Learn how to Protect Your Finances From Green Restrictions. 

Regardless of how fast and furious these laws seem, they are coming regardless and will continue to shape the need for office space indefinitely. 

Rising Vacancy Rates

The office market is expected to be further influenced by rising vacancy rates as the gray market of under occupied spaces reaches its expiration.

According to the Office Apocalypse, 70% of leases signed pre-pandemic are approaching renewal. And if the 30% that already came due caused 17% of the total leasing revenue to drop, what do you think as the rest of those 70% approach their expiration?

Since so many companies can slash their CRE costs through integrating remote/ hybrid work, many offices are sitting severely underutilized. 

Right now, the true severity of the office market’s struggles is being concealed by vacancy rates that only tell half the story. Behind all the empty buildings are offices that are wildly unoccupied due to the prevalence of remote and hybrid schedules compounded with rising costs and inflation. Businesses simply do not need as large a footprint demanded in the past and are occupying their leases not at optimum capacity until their expiration ends and they can find a location that suits their new streamlined footprint.

The good news for tenants is that under-occupied buildings coming due will create opportunities for businesses seeking office spaces at favorable terms since landlords and property owners will need to adapt their strategies to attract tenants and maintain the value of their properties.

So, if you’re part of the other 70% of tenants approaching a pre-pandemic lease renewal, you have a lot of leverage to get the terms, price, or renovations you need to upgrade your tenancy. 

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Empty Office Conversions in the Pipeline

Rampant vacancies are not only hurting the commercial real estate industry. Zombie buildings create a strain on an area’s livelihood, sucking the value out of prime real estate.

One of the suggested solutions has been converting old office buildings into housing.

Since the beginning of the pandemic, about 50 city blocks of office space throughout America have been already converted or are currently being transformed into multifamily properties, according to Bisnow.  

In theory, the conversion process should allow property owners to kill two birds with one stone. They can capitalize on the sustained growth of housing demand while making the most of vacant office space. Doing so would also lessen their stake in the highly concentrated (and unsure) office market. Still, the process is a complicated one.

Execution is slow and expensive. In reality, the current number of buildings suitable for conversions is likely too few to become widespread. In part because the cost to convert is so extreme.

According to Propmodo “Besides the obvious barriers like plumbing and HVAC, office buildings have larger floor plates and a lack of windows. We will certainly see a number of office buildings get converted to residential use, but it will not solve some of the bigger issues of unused space and empty downtowns.”

So, while suggested office conversions will likely trend throughout 2023, the value of offices will need to further drop before mass conversations are commonplace.

Push For Premium Buildings

Since the office market is so saturated, new tenants have their pick of the litter. And what are they choosing? Premium offices that enhance their corporate reputation while maximizing utilization.

In this competitive office market, tenants understand the importance of making a strong impression and creating a conducive work environment for their employees. Companies are getting serious about how their workplaces influence their team members’ urge to go to the office. It’s happening now and will likely continue as more tenants approach the expiration of pre-pandemic leases.  

They recognize that their choice of office space reflects their brand image and influences how their business is perceived by clients, partners, and potential employees.

Premium offices are highly sought after because they offer a range of benefits that align with the tenants' objectives. These offices are often well-designed, featuring modern amenities, state-of-the-art technology, and flexible layouts that cater to the evolving needs of businesses. They provide an atmosphere that fosters productivity, collaboration, and employee well-being.

Additionally, premium office spaces are strategically located in prime business districts or vibrant areas with convenient access to transportation, amenities, and a thriving business community. Such locations not only contribute to the overall appeal of the office but also facilitate networking opportunities and access to a pool of talent.

In a market where vacancies are expected to rise, landlords must understand the preferences of potential tenants and adapt their offerings accordingly. They need to invest in upgrading their properties, ensuring that they meet the demands of the modern workforce. This may involve retrofitting existing spaces, incorporating smart technology, enhancing energy efficiency, and providing flexible lease terms that accommodate the evolving needs of businesses. Because again, the shift in the demand will drastically widen the divide between Class A and B/C office space.

Faster Return-To-Office in the South

The influx of Americans relocating to the sunbelt region due to the high costs of northern metropolitan areas has had a profound impact on the demand for office space. The sunbelt cities, located in the southern part of the United States, have emerged as hotspots for real estate investment and business growth.

The allure of the sunbelt cities lies in their affordability, lower cost of living, favorable tax structures, and business-friendly environments. These factors, coupled with the rise of remote work and flexible work arrangements, have attracted individuals and businesses seeking a better quality of life and more favorable economic conditions.

As a result, the sunbelt cities have experienced explosive population growth, leading to an increased demand for office space. Learn the Top States Businesses are Moving to that will continue throughout 2023. 

Optimize Your Portfolio in 2023 and Beyond

Smart real estate moves will continue to play a critical role in the preservation of corporate EBITDA into the latter half of the year. As discussed, as a corporate tenant you possess the potential for tremendous growth despite how the market appears. There's never been a better time to reassess your commercial real estate in conjunction with the evolving opportunities that present themselves. And, you don't have to do it alone.   

Tenant Reps are CRE experts who only protect the interests of corporate tenants. At iOptimize Realty® we are True Tenant Reps™. This means we never work for landlords, and we have a sole fiduciary to you, the corporate client. We employ extensive due diligence and market knowledge to capitalize on commercial real estate trends so you can stay up to date. Subscribe to our blog to stay on top of the latest.