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The U.S. office market has been depressed since the start of the pandemic, when employees were first told to go home. Some employees, especially younger ones, never return, leaving many office buildings half-full or empty.
However, the overall office vacancy rate fell 20 basis points in the third quarter to 18.8%, according to CBRE. Although this is still a historically high level, it marks the first time that vacancies have declined year-over-year since the first quarter of 2020, when the novel coronavirus spread in the United States.
Leasing activity last quarter was led by financial services and technology companies and exceeded the quarterly average over the past five years, the report said. The construction pipeline has also declined, with the annual total at its lowest level in more than a decade.
“I think we’ve definitely bottomed out. I think we’ll bottom out in 2024,” said Owen Thomas, CEO of BXP (formerly Boston Properties), the largest office REIT in the U.S., adding, “There’s a lot of positive things happening in parts of the office business, but not all of it.”
One of those benefits is lower interest rates. Thomas said there have been some large-scale debt securitizations and capital is coming back into office real estate from the debt side. He said BXP just completed a single-asset securitization of luxury office buildings in New York City and Boston.
BXP is invested almost entirely at the top of the market, with many of its tenants in financial and legal services. And that’s another good point, Thomas said. Financial services companies are experiencing significant revenue growth, thanks in part to artificial intelligence. These companies tend to use more of their space than other companies.
“These big companies want their employees back in the office, and of course they can mandate it, but what they really want is for their employees to want to come back to the office,” Thomas said. “That’s why we’re seeing a dichotomy in the office business between high-quality buildings leased by major corporations and the rest of the buildings that aren’t performing anywhere near as well as the so-called best workplace segment of the industry.”
That “premier” tier is loosely defined as the top 10% of buildings. Vacancy rates in these buildings are much lower than in other markets, averaging 11% in the cities where BXP operates, and asking rents in these markets are 55% higher, Thomas added.
However, a premier building is not necessarily a new building. It is also a building in a desirable location, especially with easy access to public transport. There are also new moves by landlords of two-story buildings to compete with so-called Class A properties.
“Many office landlords today have a strategy where they’re not trying to be the best workplace provider, they’re trying to be the best B building provider,” Thomas said. “They’re renovating buildings. They’re offering some of those amenities and offering a more value-oriented price point. So I think a lot of the demand is going to go there.”
BXP, for its part, has no particular interest in acquiring these buildings, he added. Instead, the company is putting investment money into new developments, most recently breaking ground on a $2 billion project at 343 Madison Avenue in New York City. Thomas said that despite the long construction schedule, the resulting yields are far superior to existing buildings, even at bargain prices.
Thomas is cautiously optimistic about the impact incoming mayor Zoran Mamdani will have on the city’s real estate.
“Success in one community is limited by the success of our community, so if the city doesn’t succeed, we can’t succeed,” Thomas said. “We want to do everything we can to help him understand some of the things he promised as a candidate,” specifically mentioning housing affordability and public safety.
“I’m not sitting here and saying I think it’s necessarily going to be a positive, but given the approval rights that the state has on a lot of things and some of the early decisions that he’s making, like reappointing the police chief, I think some of that gives us a constructive feeling about what the outcome of this is going to be,” Thomas said.
He pointed to New York City’s leadership in converting offices into residential areas as a model for other cities, and said the deal would work financially because rents are so high. New York state also offers tax incentives to developers, which Thomas said is encouraging.
Mr Thomas said the conversion would not solve the office vacancy problem for the rest of the country.
“The whole office market is overbuilt. You’re going to see some buildings being torn down and replaced with other buildings. We’re doing some of that in the suburbs,” Thomas said. “But the thing about conversion is that when people start talking about it, they think this is the answer.
“That would be the answer. It’s not the answer,” he said.
