As we enter 2025, the raw numbers for the office sector paint a bleak picture. The national office vacancy still hovers around 20%. Office valuations continued to decline in 2024 and may or may not have reached bottom. The keys to multiple trophy assets have been given back to lenders by some of the industry’s most savvy investors, and office utilization, while improving in many markets, is still less than two-thirds of pre-pandemic levels.
But numbers don't always tell the whole story, SIORs and other industry leaders assert.
“For all the negative news and feelings that an “officepocalypse” is upon us, It’s important for office investors to distinguish between challenges relating to the short and intermediate-term ebb and flow of office utilization versus the long-term drivers that differentiate between the winners and losers among competing buildings and projects over time,” says Gabriel Silverstein, SIOR, president of Angelic Real Estate in Austin, Texas.
THE STORY BEHIND THE NUMBERS
Silverstein likens the industry anxiety to the fears over Y2K or, more recently, the “retailpocalypse.” The former never materialized, and retail not only survived its downturn, it’s now again one of the most stable of the CRE asset classes, as brick-and-mortar vacancy rates hit their lowest level in 20 years in 2024. While the office market is miles behind that surprising recovery, there have been some encouraging signs. A December report by CBRE researchers indicated that the office market appears to be stabilizing, with positive net absorption for the past two quarters, increased demand for space, and a decrease in new office completions.
Silverstein noted a report from CoStar that indicates more than 22% of office leases in gateway markets are set to expire by mid-2026, including major leases from government and technology tenants. It is encouraging that the data indicates the average lease term for renewing and extending tenants surpassed pre-pandemic averages, driven by law firms and government tenants. New leases, while still shorter, are approaching pre-pandemic averages. “That [22%] is a big number because companies have been allowed to kick the can down the road for a couple of years at a time (by extending. Now that clarity has started to set in for these companies about how they are going to work long-term, I think a pretty good number of those will finally start to sign longer-term deals.”
While Baby Boomers and Gen-X see the office as a place to get things done and leave, he asserts that millennials and Gen Z employees see the office as a social hub and a learning laboratory.
Some believe that controversial return-to-office (RTO) mandates being instituted by high-profile employers like Amazon (and possibly the new administration) may drive increased occupancy, but Silverstein says that RTO is likely to be driven by a less obvious source – Gen Z. He affirms that company culture cannot be built remotely and hybrid work may not maximize productivity, but there’s a cultural shift underway in the office. While Baby Boomers and Gen-X see the office as a place to get things done and leave, he asserts that millennials and Gen Z employees see the office as a social hub and a learning laboratory. “I think I have consistently heard more desire for the return to office trend from younger users than from their counterparts from older generations, including in our own brokerage business,” says Silverstein. “As a long-term trend impacting value, that bodes well for future office occupancy.”
A survey by global hiring platform Indeed bears that out. The study found that 92% of Gen Z respondents who have only worked remotely felt they were “missing out on traditional workplace experiences.” 85% worried that they weren’t learning professional soft skills due to never working in a more traditional role, with 57% expressing concern that they lacked knowledge of best communication practices.
Another factor to consider in evaluating the office market is the monolithic approach taken by the business media. “The mistake that we sometimes make – and I'm certainly guilty of it – is generically looking at averages, the national numbers, and we think of the market as if it's a singular thing,” says Silverstein. “And what I think the office market stats from city to city show us is that right now, the old adage, ‘All real estate is local,’ is really true in the office market.”
"ALL REAL ESTATE IS LOCAL"
The divide between the haves and the have-not office markets in the U.S. is cavernous. In comparing major metros, San Francisco has an overall vacancy rate of 30.7%, while Miami is in the single digits at 9.8%, according to Q3 2024 Colliers data. Cities that employ a significant percentage of tech talent (Seattle, Austin, Dallas, Boston, Salt Lake City) tend to have vacancy rates above the national average, strongly correlating with the percentage of remote workers.
In Memphis, Tenn., the vacancy rate is just 11.4%, following four consecutive quarters of positive absorption. Landon Williams, SIOR, SVP for Cushman & Wakefield Commercial Advisors says that one of the drivers for the low vacancy rate is that Memphis has one of the lowest percentages of remote workers in the U.S. “One of the reasons you see office occupancy down in so many markets is that people are working remotely because of the commute time, and an hour each way is not far-fetched in many of the big markets,” observes Willaims. “So we can talk about national and global trends, but what may be happening in one market may be totally opposite in another because, at its core, all real estate is local.”
INVESTMENT SALES REMAIN LOW
While vacancy rates and leasing activity vary from market to market, the slowdown in office transactions has affected all markets. According to Commercial Edge, office sales totaled $29.2 billion through the first 10 months of the year. That total is up slightly from last year’s figure of $27.9 billion, but the price per square foot dropped from $196 to $177 per square foot. Both totals are dwarfed by $77 billion in office sales at the close of 2021, with the $293 per square foot price tag from that period highlighting the precipitous drop in valuations, a factor in stagnant investment sales.
“Despite the occupancy numbers in a market like Memphis, when it comes to investment sales in the office sector, you still have a math problem to solve,” says Williams. Loans executed five to seven years ago at a sub-4% and a 75% loan-to-value ratio that are now reaching maturity will be nearly impossible for property owners to refinance, given the decline in valuations and the current lending environment. Property owners are then faced with the dilemma: Negotiate with the bank to extend the loan (“and write an equity check to refinance the loan”) or give back the keys to the property.
Williams says that many lenders are opting to continue to “pretend and extend” rather than take ownership of the properties. “A lot of these lenders don't want the property back because #1, they don’t want to inherit a challenged property, and #2, they don’t have the human resources to manage the full wave of properties that could be coming back.” Despite the tepid investment sales market, Williams reports that “We’re still seeing some deals getting done,” specifically highly-amenitized Class A buildings with slight valuation adjustments from pre-pandemic pricing, but adds, “We’re seeing much steeper discounts on everything that's not high quality.”
The signs of stabilization are encouraging, and the market should continue to stabilize as businesses firm up their hybrid and RTO policies and commit to longer-term leases.
DISTRESSED ASSETS
The much-anticipated “fire sale” of distressed assets has never quite materialized, so the opportunity funds raised by investors have either sat idle or been deployed into other asset classes. There have been some well-publicized distressed asset sales – most notably the 23-story building at 135 West 50th Street in Midtown Manhattan that traded in 2006 for $332M and then sold last summer at an online auction for $8.5M at a 97.5% discount – but nothing like the feeding frenzy that followed the Great Financial Crisis. Distressed sales accounted for only 2.7% of transactions, as opposed to 18.5% of sales from 2009 to 2015, according to MSCI data.
The problem, says Silverstein, “is that it's been very difficult for distressed office investors to find deals that they can actually pencil and go forward on. Office conversion is expensive and difficult, but the biggest problem is the vacancy.” He cites a JLL report that states that negative net absorption remains highly concentrated in functionally obsolete, transitional assets, while differentiated and high-quality assets have largely resisted demand-driven challenges.
“To me, the classic value-add office deal is the building that's 65%-75% occupied, with some below market rents. You upgrade it to make it nicer, and you take your occupancy up to 90%,” he explains. “The vast majority of those distressed buildings have less than 25% occupancy, and that is a much steeper hill to climb.”
THE OUTLOOK
Despite the enormous challenges within the office market, the signs of stabilization are encouraging, and the market should continue to stabilize as businesses firm up their hybrid and RTO policies and commit to longer-term leases. The lack of new supply will reduce vacancy, and owners of underperforming/obsolete buildings will need to make the tough convert/renovate/demolish decisions, but the long-term outlook is more promising than the numbers would indicate.
“I think the office market is closer to a stabilization point than anybody really believes,” asserts Silverstein. “And if that significant amount of rent roll in the next two years turns into longer-term lease commitments on buildings that are already well-occupied, I don’t think you can poke holes in that as an investment thesis.”
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