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The U.S. office market has been in freefall since the start of the pandemic, when workers were first sent home. Some, especially younger ones, never returned, leaving many office buildings half full or empty.
The overall office vacancy rate, however, fell 20 basis points in the third quarter, to 18.8%, according to CBRE. While this figure remains historically high, it is the first year-over-year decline in job vacancies since the first quarter of 2020, when Covid took hold in the United States.
Leasing activity last quarter exceeded the five-year quarterly average, driven by financial services and technology companies, according to the report. The construction pipeline has also shrunk and is on track to hit its lowest annual total in more than a decade.
“I really 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 real estate investment trust in the United States. “There are a lot of positive things happening in some, but not all, of the office sector.”
One of those positives is falling interest rates. Capital is flowing back into office real estate, Thomas said, starting on the debt side, where there have been several significant debt securitizations. BXP just completed the securitization of unique assets on high-end office buildings in New York and Boston, he said.
BXP is almost entirely invested in the high end of the market, with many of its tenants in financial and legal services. And that, Thomas said, is another positive. Financial services companies are seeing strong profit growth, driven in part by artificial intelligence. These businesses also tend to use their spaces more than others.
“These big companies want their employees to come back to the office and, sure, they can mandate it, but what they really want is their employees to want to come back to the office,” Thomas said. “That’s why you see this bifurcation in the office sector, between the quality buildings that are leased by the leading companies and the rest, which don’t perform as well as what we call the premier workplace segment of the industry.”
This “prime” level is defined, roughly, as the highest 10% of buildings. The vacancy rate for these buildings is much lower than the rest of the market: 11% on average in the cities where BXP operates, Thomas said, adding that asking rents in these markets are 55% higher.
However, prime buildings are not always new buildings. These are also buildings located in desirable locations, particularly with easy access to public transportation. There has also been a new desire on the part of owners of second-tier properties to compete with so-called Class A properties.
“A lot of office owners today have a strategy that we’re not trying to be the number one workspace provider, we’re trying to be the number one B building provider,” Thomas said. “They’re renovating their buildings. They’re providing some of those amenities, and they’re pricing more value-oriented. So I think a lot of the demand will go to that.”
BXP, for its part, is not particularly interested in acquiring these buildings, he added. Instead, it is investing capital in new developments, recently launching a $2 billion project at 343 Madison Avenue in New York. Even with long construction times, Thomas said the resulting return is much better than existing buildings, even at bargain prices.
As for Mayor-elect Zohran Mamdani’s impact on the city’s real estate, Thomas is cautiously optimistic.
“Our success in any community is limited to the success of our community, so if the city doesn’t succeed, we can’t succeed either. We want to do what we can to help him understand some of the things he promised as a candidate,” Thomas said, specifically highlighting housing affordability and public safety.
“I’m not here saying I think it’s necessarily going to be positive, but I think given the approval rights the state has on a lot of things, and some of the early decisions I see the state making, like reappointing the police chief, I think some of those give us a constructive feeling about what that outcome might look like,” Thomas said.
He pointed to New York City’s example of converting office space to residential housing as a model for other cities, saying that because rents were so high, the deals worked financially. New York also implemented a tax incentive for developers, which Thomas called encouraging.
As with the rest of the country, conversions won’t solve the vacant office problem, Thomas said.
“The office market overall is overbuilt. There will be buildings that are torn down and turned into something else. We’re doing some of that in suburban areas,” Thomas said. “But conversion, when people bring that up, they think that’s going to be the answer.
“It will be an answer. It’s not the answer,” he said.