A version of this article first appeared in the CNBC Property Play newsletter with Diana Olick. Property Play covers new and evolving opportunities for real estate investors, from individuals to venture capitalists, private equity funds, family offices, institutional investors and large public companies. Sign up to receive future issues straight to your inbox.
The U.S. office market has been in crisis since the start of the pandemic, when workers were first sent home. Some, particularly younger workers, never returned, leaving many office buildings half full or empty.
However, the overall office vacancy rate fell 20 basis points to 18.8% in the third quarter, according to CBRE. While this is still a historic high, it marks the first year-over-year decline in vacancies since the first quarter of 2020, when Covid took hold in the US
According to the report, leasing activity last quarter exceeded the five-year quarterly average, driven by financial services and technology companies. The construction pipeline has also fallen and is on track to reach its lowest annual total in over a decade.
“I definitely think we've hit bottom. I think we've hit bottom in 2024,” said Owen Thomas, CEO of BXP (formerly Boston Properties), the largest office REIT in the United States.
One of these positive aspects is lower interest rates. The capital is flowing back into office properties, said Thomas, initially on the debt side, where there have been several large debt securitizations. BXP just completed individual asset securitizations for high-quality office buildings in New York City and Boston, he said.
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BXP invests almost exclusively in the top tier of the market, with many of its tenants in the financial and legal services sectors. And that, Thomas said, is another positive aspect. Financial services companies are experiencing tremendous profit growth, thanks in part to artificial intelligence. These companies also tend to utilize their space more than others.
“These leading companies want their employees to return to the office, and of course they can mandate that, but what they really want is for their employees to want to return to the office,” Thomas said. “For this reason, there is a divide in the office industry between the quality buildings that are being leased by the leading companies and the rest that are not performing nearly as well as what we call the premium workplace segment of the industry.”
This “first” tier is loosely defined as the top 10% of buildings. The vacancy rate in these buildings is far lower than the rest of the market – an average of 11% in the cities where BXP operates, Thomas said, adding that asking rents in these markets are 55% higher.
However, premier buildings are not always new buildings. These are also buildings in sought-after locations, particularly with good public transport connections. Landlords of second-floor buildings are also increasingly looking to compete with so-called Class A properties.
“Today there are a lot of office landlords who have a strategy of not being the leading workplace provider, but rather being the best B-building provider,” Thomas said. “They're renovating their buildings. They're offering some of those amenities and a more value-oriented price point. So I think a lot of the demand will come from that.”
For its part, BXP is not particularly interested in acquiring these buildings, he added. Instead, the company is pouring investment capital into new developments, recently launching a $2 billion project at 343 Madison Avenue in New York City. Even with long construction times, Thomas says the resulting return is far better than existing, even inexpensive, buildings.
As for Mayor-elect Zohran Mamdani's impact on the city's real estate, Thomas is cautiously optimistic.
“Our success in a community is limited by the success of our community. So if the city isn't successful, neither can we be. We want to do what we can to help him figure out some of the things that he promised as a candidate,” Thomas said, citing housing affordability and public safety in particular.
“I'm not sitting here saying that I think it's necessarily going to be positive, but I think given the consent rights that the state has on a lot of things and some of the early decisions that they're going to make, like reappointing the police chief, I think some of those give us a constructive spirit about this outcome,” Thomas said.
He pointed out that New York City is a model for other cities in converting office buildings into residential buildings and said the deals work financially because the rents are so high. New York has also introduced a tax incentive for developers, which Thomas said was encouraging.
As for the rest of the country, conversions won't solve the office vacancy problem, Thomas said.
“The office market as a whole is overbuilt. There will be buildings that will be torn down and converted into something else. We're doing some of that in suburban locations,” Thomas said. “But the conversion, when people look at this issue, they think this is going to be the answer.”
“It will be an answer. It is not the answer,” he said.