Second quarter office vacancy rates remain high

Background

At the onset of the pandemic, Pennsylvania officials reacted by forcing nonessential businesses to close and recommended that people who could, work from home.  This lockdown resulted in a new work-from-home culture which left many office buildings empty.  As the lockdown subsided and the pandemic appeared to wane, many employees decided to remain home instead of going back to the office.  This will likely affect the vacancy rate in Pittsburgh’s central business district (CBD) going forward as some firms will allow employees to continue to work from home and look to reduce their footprint and rental costs.

As we wrote in April 2020 (Policy Brief Vol. 20, No.11), prior to the lockdown in the fourth quarter of 2019, the vacancy rate for class A office space in Pittsburgh’s CBD stood at 15.9 percent, the highest since the recession year of 2010.  In 2013 a low of 5.2 percent was recorded—one of the lowest in the country.  All data come from real estate research firm Jones Lang LaSalle.

For the first quarter of 2021, Policy Brief Vol. 21, No. 19, commented that Pittsburgh’s CBD vacancy rate reached 18.1 percent, reflecting a further softening of demand for office space. 

With the pandemic slowing in the second quarter of 2021 and economic activity approaching normal, how has the CBD vacancy rate fared?  In this Brief, we will compare Pittsburgh’s CBD with those in Austin; Charlotte; Cincinnati; Dallas; Denver; Los Angeles; Nashville; Raleigh-Durham; San Francisco and Seattle. 

Keep in mind that the vacancy rate is a measure of available space that is not under rental agreement.  So even though a large amount of office space was not being used during the pandemic, most space was under lease and not vacant for the purpose of vacancy rate reporting. 

Office vacancy rates

In 2021’s second quarter, the class A office vacancy rate for Pittsburgh’s CBD remained flat at 18.1 percent.  Compared to the other 10 cities in the sample, it was better than Los Angeles (18.6 percent); Seattle (19.8 percent); Denver (21.8 percent); Austin (23.5 percent) and Dallas (33.3 percent).  Of the cities with lower vacancy rates, Charlotte had the lowest (12.7 percent) followed by Cincinnati (14.7 percent), San Francisco (16 percent) with Raleigh-Durham and Denver tied with a 16.2 percent vacancy rate. 

It is interesting to note that in the first quarter of 2021, Austin recorded a class A office vacancy rate in their CBD of just 16.2 percent but posted a 7.3 percentage point jump in the second quarter.  Pittsburgh was the only city in this sample to hold steady as each had seen a vacancy rate rise from the first to the second quarter. 

Looking at total vacancy rates (classes A and B) in the second quarter for the CBDs in the group reviewed, Pittsburgh once again finished in the middle at 20 percent—just slightly higher than the first quarter rate of 19.4 percent. Austin again had the largest percentage point increase going from 16 percent to 22.5 percent followed by Cincinnati with a 3.9 percentage point increase, going from 16.8 percent to 20.7 percent.  Both cities went from having a lower rate than Pittsburgh to a higher rate between quarters. 

Inventory of office space

The pandemic did slow down the development of class A office space in some cities’ CBDs, while others in the sample continued to add to their inventory.  Pittsburgh’s inventory of class A office space in the CBD remained constant at 13.5 million square feet, which is the fifth-highest amount in this sample.  Raleigh-Durham has the smallest inventory at 6.2 million while San Francisco has the most at 46 million square feet.

Four other cities in the sample—Cincinnati, Los Angeles, San Francisco and Seattle—also held constant with their inventory of class A office space.  However, Austin, Charlotte, Denver, Nashville and Raleigh-Durham added class A square footage.  Only Dallas experienced a reduction.  But it was minimal—less than one-half of a percent of the first quarter inventory. 

For all classes of space, the inventories didn’t change too much in the CBDs.  Pittsburgh’s inventory of 18.97 million square feet remained the same between the quarters.  Los Angeles, San Francisco and Seattle also held steady. Only Austin, Charlotte and Cincinnati added class B space to their inventory in the second quarter of 2021.

Absorption of office space

Perhaps the best indicator of the health of the office market is the absorption of unleased space to leased space.  Negative absorption implies that leased space became unleased or vacant.  In the first quarter of 2021 all but three cities in this sample had negative absorption of class A office space in their CBD—Charlotte, Cincinnati and Nashville.  Pittsburgh’s CBD had a negative absorption of 22,800 square feet—the smallest in the sample.  Seattle had the largest negative absorption of 857,820 square feet. 

In 2021’s second quarter, five cities had positive absorption of square footage, including Pittsburgh.  Charlotte had 657,330 square feet go from unleased to leased followed by Raleigh-Durham (116,548), Nashville (34,482) and Austin (6,524).  Pittsburgh’s CBD had a positive absorption of just 447 square feet.  That’s essentially no change considering the city has 13.5 million square feet of class A space in the CBD.

Six cities continued to shed leased space.  The city with the highest negative absorption of class A square footage in their CBD was San Francisco (1,557,895) followed by Dallas (243,103); Denver (134,804); Los Angeles (114,873); Seattle (101,238) and Cincinnati (21,995). 

When looking at both classes of space the results are more severe.  In the first quarter the same three cities—Charlotte, Cincinnati and Nashville—had positive absorption rates with the remainder having negative absorption rates.  Pittsburgh’s CBD had a negative absorption of 101,263 square feet, the second-lowest amount.  San Francisco had the highest amount (1,055,492). 

In the second quarter, only Charlotte and Nashville continued to have unleased space become leased space.  Cincinnati encountered a reversal in the second quarter as 73,400 square feet become vacant.  Raleigh-Durham also did a reversal as nearly 147,000 square feet in the CBD came under lease. 

The other cities in the sample, including Pittsburgh, had more total office space become unleased in the second quarter.  Pittsburgh’s CBD had an additional 88,638 square feet become vacant.  As noted above, Pittsburgh had 447 square feet of class A office space become leased; the 88,638 represents all class B office space.  The range runs from a low of 22,647 square feet (Austin) to 1,881,550 square feet (San Francisco).  However, San Francisco represents an outlier in this sample as the next highest city was Dallas with just 246,842 square feet of negatively absorbed space. 

Conclusion

The vacancy rate data for the second quarter shows a slower recovery for office space than for the rest of the economy.  The class A office vacancy rates in the central business district for most cities continues to rise from 2021’s first quarter to the second.

While Pittsburgh’s rate stayed constant for class A office space, the vacancy rate for both class A and B ticked up from 19.6 percent to 20 percent.  While there currently isn’t any office space being developed in the central business district, class A or B, according to the JLL data, there is almost 1.2 million square feet of office space being developed, 1.1 million class A, in the fringe and the Oakland/East End sections of the city.  This will put more pressure on the CBD as existing firms will have options to explore outside the Golden Triangle. 

The tech companies that were either spun off from the universities, or were drawn here because of them, are more flexible with employees working from home and are likely to not require much office space.  This could cause vacancy rates to climb even higher.

The much anticipated, and taxpayer-subsidized, office building at the former Civic Arena site will also put pressure on an already soft office market.   

Furthermore, the business climate in the city is such that there is little to draw new firms to enter the city to assume any vacant office space.  With City Council pushing mandates covering sick leave and wages, most businesses that are unable to pass along the higher costs from these mandates will look elsewhere to set up. 

Given this climate, and the lingering, or ramping up, of the pandemic, the office buildings in the CBD will continue to have high vacancy rates. That could have consequences for property tax revenues, payroll tax revenues and the local service tax collections.

Economic policies and Pittsburgh office vacancies

Summary: Pittsburgh’s central business district’s (CBD) class A office space vacancy rate continues to climb. As a prior Policy Brief (Vol. 20, No. 11) reported, the vacancy rate already had reached a 10-year high of 15.9 percent in the fourth quarter of 2019. That mark preceded the onset of COVID-19 and was remarkable because six years earlier in 2013, Pittsburgh’s CBD had the second-lowest class A office vacancy rate (5.2 percent) among 53 major U.S. cities. What’s behind the latest number and what’s ahead?___________________________________________________________________________________________________________________________

An April 2020 Policy Brief (Vol. 20, No. 11) reported that the vacancy rate for Pittsburgh’s central business district’s (CBD) class A office space reached a 10-year high of 15.9 percent in the fourth quarter of 2019. That mark preceded the onset of COVID-19 and was remarkable because six years earlier in 2013, Pittsburgh’s CBD had the second-lowest class A office vacancy rate (5.2 percent) among 53 major U.S. cities.

First quarter 2021 vacancy data compiled by the research firm Jones Lang LaSalle (JLL) point to a further softening of demand for office space in Pittsburgh’s CBD. The latest data show Pittsburgh’s CBD class A office vacancy rate had climbed to 18.1 percent, a 13.8 percent increase from the fourth quarter of 2019.

Bear in mind that the vacancy rate is a measure of available space that is not under a rental agreement.  So even though a large amount of Downtown space was not being used during the pandemic lockdown, most of the leased space was still under contract and thus not vacant for purposes of vacancy rate reporting. However, as some leases expired, no doubt the lockdown and economic conditions that produced financial hardship for some firms resulted in fewer square feet being leased. Hence, the rise in unleased space that is reflected in the 18.1 percent vacancy rate.

The U.S. economy was hard hit by the pandemic with some states faring worse than others depending on gubernatorial responses.  Thus, the question; how does Pittsburgh’s latest vacancy rate compare to cities across the country?

Vacancy rates for a group of 13 cities representing a geographical cross section were chosen for comparison. Within the group only four cities had a higher rate than Pittsburgh’s first quarter CBD rate of 18.1 percent: Los Angeles (18.2 percent); Seattle (19.3 percent); Dallas (32.0 percent); and Denver (20.1 percent). Pittsburgh’s first quarter vacancy rate was higher than Austin (16.2 percent); Boston (9.0 percent); Charlotte (10.3 percent); Cincinnati (14.4 percent); Columbus (14.6 percent); New York City (12.3 percent); Nashville (16.1 percent); Raleigh-Durham (14.8 percent); and San Francisco (12.6 percent).  

It is likely that some cities saw an increase in office vacancy due to the economic fallout from COVID-19. The extent of the pandemic effect will not be fully known until there is a full economic recovery.

The problem for Pittsburgh is that the vacancy rate had significantly increased prior to COVID-19 and the economic “lockdown” only further exacerbated it.  The buildout of office space and slow employment gains lifted the vacancy rate over the previous 10 years.

But it is important to keep in mind that Pennsylvania’s prolonged COVID-19 restrictions compelled many companies to implement work-from-home options and those restrictions continue to hurt the utilization of Downtown office space.  The big question for many firms will be to what extent the work-from-home phenomenon continues and at what level after the all-clear is given from the COVID-19 pandemic.  That phenomenon is also likely to be a factor in the other cities.

Within the Pittsburgh area’s market, the Oakland/East End neighborhood displayed a significant jump in class A office space vacancy, more than doubling the vacancy from the fourth quarter 2019 (6.9 percent) to first quarter 2021 (16.4 percent). Demand may continue to diminish as companies continue to allow work-from-home options. This is especially true for sectors such as technology. In this case, most of the office space in the East End was leased to technology companies. So, while some companies will resume office leases once COVID-19 restrictions are lifted the demand will still be less than pre-COVID-19 due to the rising trend of work-from-home options.

The 2013 Pittsburgh’s CBD class A office vacancy was 5.2 percent.  But it has increased since.  At the beginning of 2020 EQT reduced its lease in EQT Plaza from fifteen floors to five. Now the skyscraper bearing EQT’s name only uses 15 percent of the space in a 32-story skyscraper. Currently, the building has 125,300 square feet available for lease out of about 600,000 square feet. EQT’s lease ends in 2024 and there is a high probability that the company will move its headquarters closer to its operations in Washington and Greene counties, dealing another blow to Downtown’s tenuous office market.

The problem is a failure to attract new companies and businesses already in the city not adding significantly to payrolls.  The city and state’s business regulatory environments deter growth. The advancement the city made in 2013 due to growth in energy and technology sectors has since tapered off.  Many of the energy-related companies have moved away from Downtown as well. This decline has not been replaced with new business arrivals. The city has been unable to sustain its attraction of new businesses.  

Many of Pittsburgh’s new technology companies related to the robotics industry have chosen office space away from the CBD. The majority of companies are located in “robotics row” in the Strip District and lower Lawrenceville area. Downtown’s skyscrapers have failed to entice.

Optimism for the Pittsburgh market of late has been focused on Gecko Robotics 69,000 square foot lease in Nova Place. However, Nova Place is on the North Side and does not contribute to CBD market’s vacancy rates. Then too, 69,000 square feet of office space is minor compared to the total space (class A and B) in the CBD and greater Pittsburgh area—18,972,607 and 35,996,246 square feet, respectively.

Google has recently added three more floors to its lease at Bakery Square. Again, this cannot be hailed as a sign of significant growth when Google’s total lease (including the new lease) is about 300,000 square feet. While both of these developments have been cited as demonstrating growth in the market, they have failed to prevent the rise in the CBD class A vacancy rate.   

Moreover, the recent announcement that First National Bank of Pennsylvania (FNB Financial Group) has the go ahead to build a 26-story office tower, creating 500,000 square feet of office space on the site of the former Civic Arena, is almost certainly going to exacerbate the vacancy rate Downtown. It will increase office space to the already saturated Downtown market.

Worse still, the new skyscraper will be subsidized by taxpayers. Which begs the question; why are taxpayers subsidizing a private company’s new construction, especially when there are already high vacancy rates for office space in the CBD?

In all likelihood, owners of commercial properties that have high vacancies and diminished lease revenue might well appeal their property tax assessment.  To the extent these appeals succeed, tax revenue to the county, city and school district will be reduced.  Yet another example of policymakers ignoring market forces with predictable consequences.

Pittsburgh’s CBD class A office vacancies highlight and reflect the problems plaguing the City of Pittsburgh.  An anti-free market regulatory environment that deters business growth, along with city-subsidized projects that have a strong likelihood of failure, combined with the strict COVID-19 economic restrictions, have contributed greatly to the prospect of further increases in office vacancies in Pittsburgh.  

Unfortunately, if the past is prologue, there appears to be little hope of meaningful change with respect to the city’s understanding of its role in promoting economic growth.