Office Slump Might Be Over

Sebastien Callebaut -

A New Chapter for the U.S. Office Market

As companies increasingly mandate employees' return to the office, the U.S. office market might be experiencing a cautious resurgence after years of pandemic-induced upheaval. Despite substantial challenges such as high vacancy rates and rising defaults, signs of stabilization suggest that the decline in demand for office space may be leveling off, even as businesses re-evaluate how they approach office environments.

  • Amazon, for example, recently required corporate staff to return to the office five days a week, signaling its commitment to in-person work.
  • Other firms are also revisiting these policies; Dell Technologies is calling its global sales team back to the office, and 3M has raised expectations for senior staff attendance.

According to Flex Index, about one-third of companies required full-time in-office attendance by the third quarter, reversing a trend of declining in-office mandates over the past five quarters. This shift reflects the changing dynamics in the labor market, with slower white-collar job growth shifting power back to employers.

Vacancy Rates and Challenges for the Office Market

While it's unlikely that workplaces will revert entirely to their pre-pandemic structures, many executives see a return to the office as essential for fostering company culture and productivity.

  • Even with signs of a rebound, the office market faces significant headwinds. The vacancy rate remains near a record high of 13.8%, a sharp increase from 9.4% in late 2019.
  • Office tenants have vacated nearly 209 million square feet of space since early 2020, the highest amount recorded over a four-and-a-half-year period, according to CoStar Group. Many office spaces now sit empty, and much of this vacant inventory is considered obsolete and unlikely to attract new tenants.
  • Compounding this issue are rising defaults and delinquency rates on office loans. In September, the delinquency rate for office loans bundled into securities hit 8.36%, the highest since 2013. Banks report that problems with distressed office loans now far exceed those with other types of commercial real estate, which are also facing challenges from high-interest rates.

Adding to the uncertainty, roughly 40% of office leases active at the start of the pandemic have yet to mature. As these leases expire, analysts expect many tenants to reduce their office footprints further.

Bright Spots and Market Adaptations

Despite the challenges, there are bright spots in specific regions and types of office spaces. New York, for example, is seeing a decline in vacancy rates due to demand from expanding financial services and technology firms. Citadel, Ares Management, and Blue Owl Capital are all increasing their New York office presence. The artificial intelligence sector, one of the few growth areas in San Francisco, is leasing space in other markets like Denver, Atlanta, and Seattle.

  • To attract employees back to the office, many companies are investing in amenities to enhance the workplace experience.
  • Properties offering features such as gyms, outdoor spaces, and upscale dining options are increasingly popular.

HSBC Bank, for example, leased an additional 35,000 square feet at its new U.S. headquarters in Manhattan after employee attendance soared to 80% in the new space, compared to less than 40% at its previous location.

Investors Eye Opportunities

Investors are taking note of the shift in market sentiment. In October, developer Tishman Speyer completed a $3.5 billion refinancing of a renovated Rockefeller Center, the largest single-office asset refinancing on record.

  • This move signals confidence among investors in well-leased properties with strong amenities and prime locations.
  • Rob Speyer, CEO of Tishman Speyer, observed that market demand from bond buyers was rising, leading the firm to refinance the debt earlier than necessary.

Interest in distressed office properties is also rising as valuations have dropped. Real estate firm Eastdil Secured has completed $2.6 billion in office sales this year, mostly involving distressed assets disposed of by lenders, marking a notable increase from only three such sales last year.

Disclaimer

Please note that Benchmark does not produce investment advice in any form. Our articles are not research reports and are not intended to serve as the basis for any investment decision. All investments involve risk and the past performance of a security or financial product does not guarantee future returns. Investors have to conduct their own research before conducting any transaction. There is always the risk of losing parts or all of your money when you invest in securities or other financial products.

Credits

Photo by Annie Spratt / Unsplash.