Introduction: The office vacancy rates for the third quarter were recently released by real estate firm Jones Lang LaSalle (JLL), where it was noted that “Pittsburgh’s office market shows recovery signs with declining vacancies” when compared to data from the second quarter. While one quarter does not represent a trend, any positive news would be welcomed by the area’s beleaguered office market.
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Office vacancy rates
The vacancy rates for total office space (all classes) in the Pittsburgh area changed little from this year’s second to third quarter 2024. However, that minor change was downward. The suburban rate fell by 0.6 percentage points, the urban rate by 0.2 percentage points and the central business district (CBD) fell by 0.1 percentage points. The best performer in the urban sector was in the Oakland/East End area, which had its vacancy rate fall by 1.4 percentage points.
Of course, all are higher than when compared to the pre-pandemic levels of fourth-quarter 2019 with the overall urban rate 4.9 percentage points higher and the CBD rate up 2.6 percentage points. The Oakland/East End rate is 20.2 percentage points higher. The suburban rate is 2.2 percentage points higher.
Class A office space, representing the best, or trophy, buildings, was also relatively unchanged between the quarters. The suburban and urban rates ticked down slightly, by 0.7 and 0.1 percentage points, respectively. The CBD was up 0.2 percentage points while the Oakland/East End market was down 2.4 percentage points.
One possible reason to explain the lower vacancy rates, especially in the CBD, is the movement to convert office buildings into residential spaces. The thought is that as office space is converted into residential, the inventory of office square footage available will be reduced and vacancy rates will begin to drop. While this is mathematically true, it doesn’t cover the fact that businesses have left the CBD.
Inventory of office space
While some conversions have taken place, most notably the former GNC headquarters, the Triangle Building and the Allegheny Building, there hasn’t been much of a drop in the inventory of office space square footage. By comparing the amount of square footage of inventory in 2019’s fourth quarter to that of 2024’s third quarter shows that there is more office space than before.
In the suburban market there is 2.15 million more square feet of total office space (all classes) in 2024’s third quarter than in 2019, while the urban market has 5.6 million more square feet. Pittsburgh’s CBD has 2.5 million more square feet while the Oakland/East End market has 1.5 million more and the Fringe market of the Strip District and North Shore have 1.6 million more.
There has been a minor reduction in the inventory of total office space when comparing the second quarter to the third quarter. For both the urban market and the CBD, the inventory of total office space has dipped by about 65,000 and 75,000 square feet, respectively.
However, this reduction was not in Class A space, it was for Class B and lower space. Class A space was unchanged in the CBD and was up in the Oakland/East End by 7,368 square feet. As was noted in a previous Policy Brief (Vol. 24, No. 35), Class B and lower space is the most likely to be converted from office to residential. The three buildings mentioned above fell into that category. The urban Class B inventory fell by 75,521 square feet while the CBD’s Class B inventory fell by 78,521 square feet. The Oakland/East End market added another 6,000 square feet of Class B space.
It’s worth noting that the new FNB tower being built at the former Civic Arena site, with taxpayer assistance, has been the only space under development for quite some time and will be officially open in the fourth quarter, adding 469,452 square feet of Class A space. There isn’t any other space under development for any class of building.
National market
JLL provided an analysis of the national office space market and notes that the office market is tightening for the first time since pre-pandemic 2019.
The demand is growing due to more companies nationwide enacting return-to-work policies. Companies have noticed that when an employee is physically present in the office their productivity is higher, they are more innovative and have higher levels of engagement and retention. As a result, some firms are considering expanding their office footprint to accommodate returning employees.
There is also a “new-to-market” demand in some markets as AI firms are growing nationally. In all, downsizing rates are slowing, even though net absorption rates are still negative, indicating that more space is becoming unleased than leased. For the Pittsburgh market, the third quarter suburban absorption total for all classes of space has been positive, more space becoming leased than unleased, while the urban areas are still seeing negative absorption.
On the supply side the thought is that the conversion process is removing square footage from the national market. The study admits that not all buildings are suited for conversion. As was noted in the above-mentioned Policy Brief, the ideal candidate is a Class B or lower, older building that is nearly all vacant. Renovations will be costly and disruptive.
The JLL report notes Seattle and Denver as cities that have facilitated the process. Seattle has passed legislation removing regulations on developers such as eliminating the affordable housing requirement and lessening design standards. Washington state has also passed a construction sales tax break. Denver offered to streamline the permitting process to make it easier for developers and will expand preservation tax credits.
Pittsburgh
The one advantage those two cities have is a demand for housing. In a recent newspaper article, the Pittsburgh metro area’s market for homes “hit the brakes this year, with home sales plunging 12.7% year-over-year—one of the steepest drops in the nation.” The three completed office-to-residential conversions added 490 apartments to the city inventory. That supply is forecasted to increase even more as Three Gateway Center is trying to begin conversion and the owners of the Gulf Tower also would like to add apartments. From where will the buyers for these apartments come? The Pittsburgh metro area’s population is stagnant at best.
Pennsylvania’s governor, along with a coalition of local businesses and the Pittsburgh Urban Redevelopment Authority, are proposing a plan to revitalize downtown Pittsburgh. The plan will include $22 million in state money, of the $62.6 million the state dedicated for the entire project, for five mixed-use projects with office-to-residential conversion resulting in 800 new residential units. The public money will require more regulations such as the use of prevailing wages in construction and the requirement that a certain portion of apartments be available for those with low incomes. In this case, 135 new affordable units or 17 percent of the total.
Both regulations will increase costs and reduce profitability.
Conclusion
Taxpayers have no business subsidizing private developers. They alone should assume the risks of the market and reap the benefits. Government intervention will not turn around the fortunes of Pittsburgh. Government officials should work to improve the economy, attract and nurture businesses, clean up the homelessness and crime and then the residents will follow. This is the best path to restoring Pittsburgh to sustainable prosperity.
