What Many Get Wrong About the US Office Market

There’s a widely accepted narrative about the office market:

• Covid-19 came and companies, often under government demand, closed their offices and had people work from home.
• When things returned more or less to normal, employees didn’t want to return, despite executive insistence.
• Because of tight labor markets, employees had more leverage, so office buildings faced significant drops in occupancy.
• Over time, companies realized they had less need for office real estate and started to pare back, leaving many office owners facing big trouble.

An easy four-step journey. And if Brookfield is correct, one that has embraced some big misconceptions. They argue that too much office inventory isn’t the issue. Rather, it’s too little inventory of the right sort. “There is an excess of dated, functionally obsolete office buildings and an undersupply of offices that satisfy tenants’ changing needs,” they wrote. Instead of companies not needing office space, “tenant preferences have shifted to buildings with modern amenities and functionality, and the recent rise in interest rates has exposed older office buildings as uneconomical.”

That will lead to a “distribution of outcomes for owners, lenders, and local communities,” because the uneconomical buildings don’t have the financial strength to continue existing as they do.

Brookfield goes on to offer a startling number, that 90% of all office vacancies are in the bottom 30% of buildings, “largely characterized by older offices with limited amenities and reduced functionality.” The top 25% of buildings, in comparison, see stable vacancy rates and record-high rents. “We believe this growing divide will only widen as legacy leases expire and tenants look for new space that reflects evolving business culture to engage employees and meet sustainability goals,” they write.

This fits with the “flight to quality” trend that GlobeSt.com sources have noted. This is particularly true, according to many, as companies decide to reduce their footprint and use the opportunity to find better space.

There is a limit to the improve-and-move theory, however. Cushman & Wakefield recently asked whether there is enough appropriate office space to meet flight-to-quality demand. The answer is yes, for the immediate time, but not for too long. Other reports have also raised doubts about whether this trend is, in fact, real.

The most attractive and desirable office space is only between 10% and 15% of total inventory, Cushman said. Demand for the buildings is high. Top-tier space in gateway markets enjoys vacancy rates that are 700 basis points lower than the remaining market. “Direct vacancy in the best buildings is sub-11%,” an impressive number in relative comparison.

There’s an inherent development that led to office bifurcation, as Brookfield says. As office supply developed between 1990 and 2022, businesses heavily digitized how they operated.

“There is no agreed upon universal metric for measuring the amount of office space needed in any given market,” Brookfield writes. “But with the adoption of modern technology, it is generally accepted that fewer square feet of office space are needed by today’s corporations than in the past. The level of excess office inventory in the U.S. relative to the rest of the world is particularly pronounced when measured on a per capita basis.”

The firm’s view of the future was a bit grim. “To resolve the vacancy issues plaguing office real estate, we believe a large portion of these older office buildings will need to be repositioned, repurposed or demolished,” they wrote.