In June, Capital Economics published a report written by the firm’s deputy chief property economist, Kiran Raichura, suggesting that the “35% plunge in office values we’re forecasting by end-2025 is unlikely to be recovered even by 2040.” To put it simply, it’s unlikely that offices will regain their peak values in the next 17 years because lower demand that’s a direct result of remote work (a trend that’s proving to outlast the pandemic), in their view.
In a separate report, also written by Raichura and Capital Economics’ assistant economist, Charlie Cornes, they said that “further downgrades to our national office outlook have driven corresponding cuts to return prospects in our metro-level forecasts this quarter.” They are broken down by the six major markets, southern metros, and western metros. That being said, the firm forecasts San Francisco office values will drop 40%, at the very least, in the next couple of years, between 2023 and 2025.
“The issues facing San Francisco probably require little introduction,” they wrote. “A high share of tech, high rent levels, expensive housing and a growing crime and homelessness problem downtown all mean that San Francisco office owners are set for a torrid time over the coming years.”
With that, Capital Economics expects San Francisco’s negative absorption will continue for the next three years—which basically means the firm expects there to be more vacated space than what was leased and absorbed by tenants. They also expect vacancy to rise by almost 500 basis points from its end of 2022 level, asking rents to fall, and gross yields to reach 8.4% by the end of next year. All of which is bad news for net operating income.
“Combined with weak outlooks for NOIs, those yield rises paint a poor picture for capital values,” Raichura and Cornes wrote. “San Francisco is set to lead the pack lower in 2023-25, with a capital value fall of 40%-45%.”
Of the six major markets, which includes: Boston, Chicago, Los Angeles, San Francisco, New York City, and Washington D.C., Capital Economics expects negative absorption in each one for the 2023 to 2025 period.
Additionally, economists pointed out that office-based job growth started out poorly this year in each of those markets except for Boston (although they expect it to slow down next year). Still, demand is slow in Boston, with “four consecutive quarters of negative absorption, with the first two months of Q2 faring no better,” economists said, citing Real Estate Information Standards data. Therefore, they forecast vacancy will reach nearly 19% by the end of 2025, which they say will have an effect on rent growth but not enough to keep Boston from outperforming all of the other five major markets.
As for Chicago, Raichura and Cornes say they expect vacancy to keep rising that’ll in turn keep rent growth weak. And for Washington D.C., their outlook is “fairly poor” given the market’s below-par job growth and negative net absorption as a result of the public sector’s higher rate of remote work than initially expected.
“The outlook for demand in both Los Angeles and New York City is also poor,” the economists wrote, citing lagging office job growth and negative absorption because of lengthy commutes, high housing costs, and high office rents in New York City, specifically.
Two of the southern metros, which includes: Atlanta, Austin, Dallas, Houston, and Miami experienced strong office-based job growth—those two being: Dallas and Houston. With that, across all of the southern metros, Capital Economics suggests that office usage will stay higher compared to the six major metros mentioned above. “Together, higher office utilization and strong employment growth will support southern office demand,” Raichura and Cornes wrote. Although they do see an almost 25% office value decline in Austin this year, which they say is the largest for the south.
“However, total returns will be positive for all southern metros on a five-year basis, outperforming the national average,” economists wrote. “Indeed, Dallas, Atlanta and Miami are forecast to be the top-performing markets over the next five years.”
Now for western metros (Denver, Phoenix, Portland, San Diego, San Jose, and Seattle), Raichura and Cornes wrote that office job growth had underperformed against the national average for the past few months. Seattle has seen barely any growth, Denver experienced nine consecutive months of negative growth, and Portland is experiencing a sudden slowdown.
“The region’s high exposure to the rate-sensitive tech sector has meant the current tightening cycle has weighed heavily on office employment,” economists wrote, adding that they expect negative absorption rates over the couple of years in Portland, Denver, and Seattle. And in San Diego, they predict a 15% decline in office capital values this year, that’ll only begin to see growth in 2026.
But there’s one market that seems to be rivaling San Francisco, and that’s Seattle.
“Tech layoffs pushed demand in Seattle negative in 2022, causing vacancy to rise despite historically-low completions that year,” Raichura and Cornes wrote, adding that they expect vacancy to peak above 20% and a larger rise in yields. That’s all contributed to their forecast that office capital values in Seattle will decline by over 30% this year, which is slightly larger than San Francisco and the largest fall across all our 17 metros for the year. But for the 2023 to 2025 period, Capital Economics expects the two markets will have a “similar fall.”
