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The U.S. office market has been in a tailspin since the start of the pandemic, when workers were first ordered home. Some, especially younger workers, never came back — leaving many office buildings half full or empty.
The overall vacancy rate for offices, however, fell 20 basis points in the third quarter to 18.8%, according to CBRE. While that’s still historically high, it marks the first year-over-year decline in vacancy since the first quarter of 2020, when Covid took hold in the U.S.
Leasing activity last quarter exceeded the five-year quarterly average, driven by financial services and technology firms, according to the report. The construction pipeline also dropped and is on track for the lowest annual total in over a decade.
“I definitely think we hit bottom. I think we hit bottom in 2024,” said Owen Thomas, CEO of BXP (formerly Boston Properties), the largest office REIT in the U.S. “There are lots of positive things that are going on for part, not all, of the office business.”
One of those positives is lower interest rates. Capital is coming back to office real estate, Thomas said, starting on the debt side, where there have been several large debt securitizations. BXP just completed single-asset securitizations on high-end office buildings in New York City and Boston, he said.
BXP is almost entirely invested in the top tier of the market, with many of its tenants in financial and legal services. And that, Thomas said, is another positive. Financial services firms are seeing big earnings growth, in part thanks to artificial intelligence. These firms also tend to use their spaces more than others.
“These leading companies want to get their people back in the office, and, of course, they can mandate that, but what they really want is they want their people to want to come back to the office,” said Thomas. “That’s why you’re seeing this bifurcation in the office business, between the quality buildings that are being leased by the leading companies and then the rest, which are not performing nearly as well as the, what we call, premier workplace segment of the industry.”
That “premier” tier is defined, roughly, as the top 10% of buildings. The vacancy rate in these buildings is far lower than the rest of the market — 11% on average in the cities where BXP operates, Thomas said, adding that the asking rents in those markets are 55% higher.
Premier buildings, however, are not always new buildings. They’re also buildings in desirable locations, especially with easy access to mass transit. There has also been a new drive from landlords of second-tier buildings to compete with so-called Class A properties.
“There are many office landlords today that have a strategy of, we’re not trying to be the premier workplace provider, we’re trying to be the best B building provider,” Thomas said. “They are fixing up their buildings. They’re providing some of these amenities, and they’re providing a more value-oriented price point. 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’s putting investment capital into new development, recently launching a $2 billion project at 343 Madison Avenue in New York City. Even with construction timelines long, Thomas said the resulting yield is far better than existing, even bargain-priced buildings.
As for the effect of Mayor-elect Zohran Mamdani on the city’s real estate, Thomas is very cautiously optimistic.
“Our success in any one community is capped at our community’s success, so if the city’s not successful, we can’t be either. We want to do what we can to help him figure out some of the things that he promised as a candidate,” Thomas said, specifically noting housing affordability and public safety.
“I’m not sitting here saying that I think it’s necessarily going to be a positive, but I do think, given the approval rights that the state has over many things, and some of the early decisions I see him making, like reappointing the chief of police, I think some of those are making us feel constructive about what this outcome might look like,” said Thomas.
He did point to New York City’s lead in office conversions to residential as a model for other cities, saying that because rents are so high the deals work financially. New York also put a tax incentive in for developers, which Thomas called encouraging.
As for the rest of the country, conversions won’t solve the office vacancy problem, Thomas said.
“The office market overall is overbuilt. There are going to be buildings that are demolished and made into something else. We’re doing some of it in suburban locations,” said Thomas. “But the conversion, when people get onto this topic, they think this is going to be the answer.
“It’s going to be an answer. It’s not the answer,” he said.
