Office Real Estate Sector Shows Signs of Optimism Despite Persistent Challenges
The latest episode of America’s Commercial Real Estate Show featured an insightful discussion about the U.S. office market. Hosted by a seasoned real estate expert, the show welcomed Phil Mobley, National Director of Office Analytics at CoStar. The conversation centered on the state of the office property sector, from current performance trends to future forecasts, and shed light on the dynamics shaping the market during one of its most challenging periods. Note that though Miami gets a mentioned as a bright spot, this conversation is generally national in scope, thus observations can apply less if at all to Miami and other South Florida Markets.
Positive Absorption—A Sign of Stability?
Phil Mobley began by highlighting a significant development: positive absorption in the office sector for the first time in over two years. While modest at around 2 million square feet, this uptick marked a step toward stability. However, Mobley cautioned that this alone doesn’t signal a full recovery. The national vacancy rate ticked up slightly to 13.8% due to new supply, and CoStar forecasts suggest vacancy may peak around 15.5% before leveling off. Mobley emphasized that not all vacant space is equally competitive, with many older office properties struggling to attract tenants.
Supply Challenges and Conversions
Supply-side dynamics have become more prominent, Mobley noted, as construction slows and building demolitions rise. Interestingly, conversions of office buildings into other uses—such as residential or mixed-use spaces—are also on the rise. While conversions are unlikely to dramatically shift market fundamentals, they are transforming neighborhoods, particularly in cities like Boston.
Mobley also pointed out that new supply deliveries are at historically low levels, which could help ease future vacancy concerns. He projected that annual net new supply could drop to as little as 5 million square feet by 2027. However, he anticipates a rebound in construction activity for specific property types, such as medical offices and owner-occupied campuses.
Geographic and Market Bright Spots – Miami Mentioned as a Bright Spot
The discussion revealed several bright spots in the office market, particularly for smaller tenants and owner-occupants. Professional service firms and locally focused businesses are actively leasing space, driving a surge in smaller lease deals. Additionally, owner-occupiers have become a significant force in the capital markets, accounting for nearly 25% of office sales—a notable increase from historical norms.
When it comes to geographic differences, cities like Houston and Miami stand out. Both markets are seeing higher-than-average leasing activity and have not experienced the same dip in lease size that other cities have seen. Other growth markets, such as Austin and Nashville, continue to perform well, driven by employment growth in knowledge-based industries.
Valuation and Transaction Activity
One of the more striking points Mobley made was the wide range in office property valuations. Buildings in major markets with large vacancies are selling for 25-30% of their pre-pandemic values. However, niche sectors such as medical offices have retained more of their value, with only a 10-15% decrease from their peak. Mobley expects values to continue to adjust downward by another 5-10% in the near future as interest rates stabilize.
Transaction volume has been significantly lower than pre-pandemic levels, with investment sales activity down by about two-thirds. However, the potential for increased distressed sales, particularly in markets with rising delinquency rates, could spur more activity in the coming years.
Looking Ahead: Opportunities Amidst Challenges
While the overall office market may remain subdued for the foreseeable future, Mobley emphasized that there will be opportunities for strategic investors and operators. As demand shifts and vacancy rates stabilize, tactical plays will become increasingly important. Investors focusing on location, tenant needs, and asset management will likely find success, even as the broader market remains challenging.
The show host closed the conversation on a hopeful note, drawing comparisons to other sectors that have rebounded after periods of intense pessimism, such as retail and housing. He suggested that office real estate, though struggling now, could offer significant opportunities for contrarian investors willing to take the plunge.
Conclusion
The U.S. office market is in a state of flux, with performance varying widely based on geography, property type, and tenant demand. While the sector is not expected to fully recover in the short term, the slowdown in new supply and the rise in tactical investment opportunities provide reasons for cautious optimism. As always in commercial real estate, those who can navigate the complexities of the market stand to benefit the most. For users or investors considering office space acquisitions, this may be an ideal time to explore opportunities, particularly in niche markets or for owner-occupants.