U.S. Macro Outlook: Mild Recession ≠ Pleasant

CUSHMAN & WAKEFIELD RESEARCH U.S. Macro Outlook

ECONOMY

investment trust (REIT) values to know that the commercial real estate (CRE) sector is in for a tough ride. The Dow Jones Equity Composite REIT Index is down 14% YoY, as of January 2023, but is 20% off its recent peak. Some sectors have been hit even harder, namely the Office REIT Index that is down 27% YoY, and 33% from its recent peak. Overall, 2023 will be a difficult year for many sectors of the economy, including property. It will be a year that will likely feature a recession, increased volatility and harsher demand conditions. Of course, all real estate is intensely local, and there will be certain sectors and geographies that will outperform and others that will underperform. Moreover, it is precisely periods like this—periods of volatility—that create tremendous opportunity for both occupiers of real estate and investors, and the stage is set for a growth story to reemerge in 2024 and even more so in 2025. The Age of Trifurcation Is Here U.S. office-using industries catapulted out of the pandemic recession with significant job gains; there are now 1.9 million more office jobs than there were prior to the pandemic. Of those jobs, about 25% were directly tied to technology, which accounted for only 15% of office jobs prior to the pandemic. Even as tech layoff announcements have gained attention in the media, they have yet to result in major net declines in employment, meaning that hiring is offsetting most layoffs. Further, there is tremendous competition for highly skilled tech workers in occupations like software development or programming. The unemployment rate for highly skilled tech workers is just 2.3% compared to 3.4% for all workers. Unfortunately, despite strong job creation by office firms, the office real estate market has experienced a different state of affairs since the pandemic hit, and the historically strong correlation between jobs and demand has decoupled. The U.S. office sector has shed 189 million square feet (msf) of occupied space since the pandemic began and remote working effects took hold. For context, this is nearly double the amount of space shed during the Great Recession and the dot-com recession. U.S. office vacancy now sits at 18.2%, up from 12.9% prior to the recession brought about by the pandemic. From first quarter 2020 to fourth quarter 2022, effective rents—which account for tenant improvements and free rent—have declined by 14%.

The U.S. office market is not a monolith, of course. New construction and office space that caters to hybrid workplace strategies remains in high demand. Over the last three years (2020-2022), this segment of the market registered over 100 msf of positive absorption. Moreover, certain geographies are bucking the national downtrend. Of the 90 markets Cushman & Wakefield tracks, 29 registered positive absorption in 2022. From a demand perspective, the top performing markets fall into one of four categories: 1) major Sun Belt markets, 2) gateway adjacent markets, 3) markets with a strong tech or life science lab sectors, and 4) smaller markets with strong job recoveries.

IMPACT OF WFH ON VACANCY RECOVERY

24%

22%

20%

18%

OFFICE

16%

14%

12%

2021Q2

2021Q4

2019Q4 CBD

2027Q2

2022Q2

2023Q2

2025Q2 Total U.S.

2026Q2

2027Q4

2022Q4 Non-CBD

2024Q2

2023Q4

2025Q4

2020Q2

2026Q4

2024Q4

2020Q4

CBD w/ WFH

Non-CBD w/ WFH Total U.S. w/ WFH

Source: Cushman & Wakefield Research

It is important to recognize that signs of recovery were forming through the middle of last year. Net absorption was sharply negative in 2020 and the first half of 2021, averaging -28.8 msf per quarter. But starting in late 2021 and early 2022, the absorption trends became significantly less negative, averaging -3.0 msf per quarter. In terms of the negative absorption, it appeared that the worst was over. Businesses can only cut so much space, and the office sector was on the cusp of absorbing space again. Indeed, in fourth quarter of 2021, absorption was positive in more than half of all U.S. markets, and since then more than 30 markets per quarter were posting positive demand. The recovery was cut short by the factors we mention next, but a demand recovery was underway, and we think these are signs that demand for office space should turn positive once the U.S gets past the recession. Nationally, demand for office space started to recede again in the second half of 2022. A second wave of sublease hit the market as companies started to prepare for softer economic conditions. Some companies had become overextended— especially tech firms that were active throughout the pandemic—and began to return some of the

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