The U.S. is facing a tremendous challenge, the scale of which is unprecedent in recent history. By mid-2020, approximately 130,000 people had died from complications of COVID-19. The spread of the disease is significantly altering day-to-day life and the economy, which shrank by an abysmal 9.5% in the second quarter. The office real estate market is being challenged by many forces, including the overall health of the economy, a reassessment of office footprints, and the potential impact of remote work on future requirements. Despite these challenges, the Indianapolis office market has not yet seen much disruption across most statistical indicators by midyear.
The Indianapolis office market direct vacancy rate has been on an upward trajectory since 2018 and ended Q2 2020 at 16.2% Strong quarterly net absorption pushed vacancy down from Q1 2020 but is still up 40 bps from Q2 2019. As expected, leasing activity dipped by 17% from last quarter as tenants hesitated to commit to new leases. Asking rents rose 4.7% year-over-year. Landlords are not budging on rental rates, instead opting for free rent and flexible lease terms to incentive new tenants.
The one-two punch of the virus and civil unrest following protests put the downtown office market in a precarious position midway through the year. An upward trajectory of vacancy continued in Q2 2020, when the rate rose by 40 basis points year-over-year to 15.8%. Space actively being marketed jumped by 9% from the last quarter. The addition of more than 175,000 sf to the market is a warning sign of potential future vacancy. The challenges faced by CBD assets in a downturn, especially when combined with new operational issues created by the pandemic, could impact occupier activity. As of now, there is too much uncertainty to accurately predict what’s next.
North Suburban Markets
New ground-up construction is having a major impact on the suburban office market by drawing tenants out of traditional office parks, especially in the Meridian Corridor, where the class A vacancy rate climbed to 19.1%. Conversely, in the Keystone Crossing submarket, vacancy tightened to 10.2%. Duke Realty Group’s move from Parkwood into its new headquarters in Keystone Crossing added to that submarket’s direct net absorption of 135,507 sf. Owners of traditional office parks are increasingly making capital improvements to amenity centers and other shared facilities to attract and retain tenants.
The two largest user purchases in the last seven years took place in 2020. Earlier this year, Knowledge Services bought the former Marsh Supermarkets headquarters building. In June, Round Room acquired the 193,000-sf facility that has been sitting vacant since 2016. The sales effectively remove two of the largest user options in the entire suburban market.
Investment sales were largely stalled in Q2 2020. Shorter lease terms could create valuation issues for capital markets, shifting the focus towards low-risk assets and distressed properties until the resurgence of a more stable office market.