Atlanta Office Market: Distress, Opportunities, and Investor Caution

Challenges in Atlanta’s Office Market

The Atlanta office market faces significant leasing and absorption challenges noted by CoStar’s recent report. Negative absorption reached -2.0 million SF in Q2. Net absorption is down more than 1 million SF since early 2020. Vacancy rates remain high at 14.8%.

Shifts in Building Preferences

Newer buildings in vibrant locations attract more new absorption. Since early 2020, over 8.2 million SF has been absorbed in buildings built since 2015. Older buildings have seen negative absorption of more than 9.3 million SF. This shift highlights the preference for modern spaces.

Increase in Available Space

Atlanta entered the year with over 61 million SF of available space, up 20% over three years. Much of this is stubborn sublet space, hindering recovery. The metro has 9.1 million SF of sublet space available, up from 3.2 million SF in early 2020. This is the highest in market history.

Rising Sublease Challenges

Sublet availability has reached unprecedented levels, surpassing peaks seen during the global financial crisis. Recent additions by companies like Cox Automotive, IBM, and Anthem contribute to this rise. The increased sublease space represents about 2.7% of the metro’s total inventory.

Declining Lease Sizes

The average lease size in Atlanta continues to shrink. Pre-pandemic, typical leases were over 5,000 SF. By 2022, the average lease size fell below 4,200 SF. Larger leases, common in corporate relocations, have also seen a steep decline.

Corporate Moves and Submarket Trends

Midtown and Northside Drive/Georgia Tech submarkets attract major corporations. Google, Microsoft, and others have moved in. Suburban areas with walkable amenities also draw attention. The northern quadrant of the metro sees significant leasing activity.

Suburban Submarket Strength

The Cumberland/Galleria and Central Perimeter submarkets have signed large leases recently. Truist and Transportation Insight’s relocations bolster these areas’ prospects. Suburban markets offer attractive alternatives to downtown.

Buckhead’s Value Proposition

Buckhead, once the premier office location, now offers value compared to Midtown. Older properties in Buckhead come at a $10/SF to $15/SF discount. This makes Buckhead an attractive option for cost-conscious tenants.

Investment Activity in Atlanta

Atlanta remains a target for large-scale capital allocators despite challenges. It’s the fourth-largest U.S. metro for office sales volume. Investment activity slowed. Significant transactions have been scarce.

Long-term Market Appeal

Despite short-term issues, Atlanta’s long-term appeal remains. Factors like regional affordability and a diverse workforce support demand. The market’s attractiveness to large capital groups underscores its enduring potential.

Competitive Landlord Incentives

Asking rents in Atlanta’s office market continue to rise, especially in trophy assets. However, landlords offer significant tenant improvement allowances and free rent. These incentives are necessary to stay competitive. Despite high asking rents, near-term rent growth may be subdued due to high availability and sublet space.

High Asking Rents in Midtown

Midtown now boasts the highest office asking rents in Atlanta. Rates exceed $40/SF, with Ponce City Market and Coda reaching over $60/SF. This trend highlights Midtown’s desirability. Yet, these rates come with substantial tenant improvement packages.

Tenant Improvement Packages

Owners of new buildings offer $80/SF to $100/SF in tenant improvement packages. They also provide at least one month of free rent per year of lease term. Older properties without nearby amenities face pressure to lower rates. This competitive environment drives landlords to offer better deals.

Pre-Pandemic Rent Growth

Before the pandemic, 4 & 5 Star assets in Atlanta saw strong rent growth. This was due to a flight-to-quality effect and limited speculative construction. However, year-over-year rent growth for these assets is now 0.0%. This marks a significant decline from pre-pandemic levels.

Suburban vs. Urban Rent Disparity

The rent gap between Midtown and suburban submarkets has widened. In 2008, the gap between Midtown and Central Perimeter was $4/SF. Today, it is nearly $12/SF. Suburban markets like Central Perimeter and Cumberland/Galleria offer competitive advantages over Midtown.

Underperforming Suburban Nodes

Secondary suburban areas like Duluth/Suwanee/Buford and Norcross/Peachtree Corners have underperformed. These areas lag behind the metro average in rent growth. This underperformance contrasts with the strong demand in more central suburban submarkets.

Impact of Sublet Space

Sublet space significantly affects many owners. The difference between asking rents for direct and sublet space is notable. This gap reached its widest point in a decade at over $7/SF. Sublet space often costs 25% less than direct leases.

Example: Central Perimeter Submarket

At Embassy Row in Central Perimeter, sublet space is listed at $19.50/SF. Direct leases in the same building were asking $27.50/SF in 2021. This disparity illustrates the financial pressure sublet space imposes on landlords. It also affects overall market dynamics.

Example: Downtown Atlanta

Downtown, at Centennial Tower, direct leases ask between $29/SF and $32.50/SF. Meanwhile, sublet space in the same building is available at $14.50/SF. This significant price difference highlights the challenges in the current market. Sublet space continues to drive down rental rates.

Conclusion: Market Dynamics

In conclusion, Atlanta’s office market faces complex dynamics. Landlords use incentives to stay competitive. High asking rents in prime locations contrast with pressures from sublet space. Long-term appeal remains, but near-term growth faces significant challenges.

Slower Development in Atlanta

New construction in Atlanta is not a primary concern. Development is slower compared to other Sun Belt metros. Atlanta has 3.2 million SF under construction, only 1.0% of its existing inventory. This is a decrease from 5.0 million SF two years ago.

Supply Pressure in Submarkets

Acute supply pressure exists in certain submarkets. Nearly 80% of the 12.5 million SF delivered since 2020 is leased. Only about 30% of under-construction properties are preleased. The overall availability rate of 18.6% is well above the national average.

Challenges for Older Buildings

Older buildings face significant challenges. Net absorption in buildings completed before 2015 has fallen by over 9 million SF since 2020. Large blocks of high-quality space remain on the market. Buckhead is a submarket to watch for this class of office space.

Buckhead’s Market Dynamics

Buckhead has a mix of new and old properties. Recent deliveries, like One Phipps Plaza, lease rapidly. Yet, nearly two-thirds of Buckhead’s supply dates from before 2000. Availability rates in older properties approach 30%, attracting value players.

Better Performance Near Amenities

Older buildings near “18-hour” activity centers fare better. Proximity to retail, restaurants, and entertainment is key. For instance, 3379 Peachtree, next to Lenox Square Mall and MARTA station, is 90% leased. New supply pressure in Buckhead remains muted.

Concentration of New Buildings

Most new buildings are in Midtown, West Atlanta, and Northside Drive/Georgia Tech. Corporate relocations from older buildings to new spaces drive this trend. Midtown has become Atlanta’s most expensive submarket due to this demand.

Corporate Relocations

Corporations like NCR and Norfolk Southern have moved to Midtown. Tech and financial giants like Google and Invesco have followed. This success has spilled over into West Midtown. Microsoft’s lease at Atlantic Station signals demand for creative office space.

Slow Materialization of Demand

Demand for new office space is slow to materialize. Many large tech companies are slowing hiring and announcing layoffs. Microsoft’s plans for a 90-acre campus near the Bankhead MARTA station are on hold. Northside Drive/Georgia Tech has high availability.

High Vacancy in New Projects

Newly delivered projects like 8West, Star Metals, and The Interlock have large blocks of available space. More than 30% of space in Northside Drive/Georgia Tech is available. Supply pressure continues to build with over 800,000 SF of office space under construction.

Future Supply Challenges

The future supply of office space in Atlanta remains a challenge. New projects are adding significant space, much of it unleased. The market must adapt to these pressures to maintain stability. Balancing new supply with demand is crucial for recovery.

Limited Office Trades

Shifting capital markets have restricted office trades in Atlanta. Sales volume reached nearly $5 billion in both 2021 and 2022. However, only $659 million traded hands. This is the lowest sales volume since 2012.

Decline in Large Office Deals

No large non-medical office deals closed. Few transactions exceeded $10 million. However, a major deal in Q2 showed continued demand for new properties in prime submarkets. Armada Hoffler purchased The Interlock for $215 million.

Lower Sales Prices Observed

The $538/SF sales price for The Interlock was lower than expected. This contrasts with higher sales prices of $650/SF to $750/SF seen in 2021 and 2022. The market is experiencing a downward pricing trend.

Market Pricing in Limbo

A lack of transactions has left market pricing uncertain. Tight financing and a disconnect between buyers and sellers inhibit pricing discovery. Closed deals reinforce a negative pricing trend as cap rates continue to rise.

Recent Transactions Highlight Trends

The sale of 6910 Powers Ferry Landing closed at $108/SF. This was slightly less than its 2017 sale price. The transaction highlights the ongoing negative pricing trend in the market.

Continued Owner-User Activity

Owner-user and 1031 exchange activity remains active. Onward Investors sold a three-property portfolio in a 1031 Exchange. The properties sold for $20 million or $101/SF at a 7.4% cap rate.

Increasing Distress in the Market

Distress has accelerated with higher interest rates. Seventeen office properties are now in special servicing. An additional 50 properties are on CMBS watchlists.

Positive Population and Job Growth

Atlanta benefits from above-average population and job growth. These factors are tailwinds for the market. However, investors remain cautious due to current market conditions.

Cap Rates and Market Caution

Confirmed cap rates for 4 & 5 Star properties range between 6% and 7%. Recent transactions are limited, masking broader increases. Sub-5% cap rates and record prices seen in 2021 and 2022 are no longer achievable.

Closing Thoughts

The Atlanta office market faces significant challenges. Limited trades, lower prices, and rising distress prevail. Population and job growth offer some optimism. Contact Lumicre for your investment needs.