The U.S. is facing a tremendous challenge, the scale of which is unprecedented in recent history. By the end of Q3 2020, nearly 210,000 people had died from complications of COVID-19. The CARES Act package and a relaxing of state and local restrictions helped the economy to rebound in Q3 20 after an abysmal Q2 2020, but uncertainty looms large. With no new federal relief package likely, an ongoing high-stakes presidential election, and a resurgence of virus cases moving into the fall, the likelihood of a stabilized economy is low. The office real estate market is being challenged by many forces, including 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 the rise since 2018 and ended Q3 2020 at 16.7% despite positive year-to-date (YTD) net absorption. As expected, YTD leasing activity fell 39% from last year as tenants hesitated to commit to new leases. Asking rents rose 3.8% year-over-year. Landlords are not budging on rental rates, instead opting for free rent and flexible lease terms to incentivize 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 Q3 2020, when the rate rose to 16.3%, which is still lower than the total market vacancy rate. The increase in employees working from home also caused some companies to offer a portion of their physical footprint for sublease amid the pandemic - adding more than 100,000 sf of sublease options to the market in the last nine months.
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 21.3%. Conversely, in the Carmel submarket, vacancy tightened to 10.6%. The completion of The Agora at the Proscenium contributed to this shift, as tenants relocated into the new project from existing suburban footprints. Owners of traditional office parks are increasingly making capital improvements to amenity centers and other shared facilities to retain tenants and building out speculative suites to attract new tenants to move-in ready space.
The two largest user purchases in the last seven years took place in 2020. In Q1 2020, Knowledge Services bought the 165,000-sf 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 mostly stalled through 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.