Office Outlook

The office sector is currently undergoing a phase of price discovery. Tenant demand for offices is low due to the remote work trend, although according to a report by LinkedIn, roughly 59% of the workforce is still working in offices.²⁴

Class A assets stand out in contrast to lower-class offices in terms of their leasing activity and therefore rent growth. An example of this is shown in recent Cushman & Wakefield data, which reveals that Class A buildings account for roughly 80% of new leasing activity in Washington, D.C., while Class B and C projects represent only 14% and 5%, respectively.²⁵ A report by CBRE analyzes what makes for a “Hardest Hit Building” after the pandemic or an “HHB” and noted that the highest occupancy loss after the pandemic was observed in downtown office buildings between 100,000 to 300,000 sq. ft that were constructed between 1980 and 2009 and situated in high-crime areas with limited nearby restaurants.²⁶ The level of distress in the office market is also dependent on the age of the offices. As of Q2 2023, the vacancy rate for offices reached 18.2%, which, according to CBRE, was the highest in 30 years. In contrast, the vacancy rate for buildings constructed after 2010 was 14.4%.²⁷

Figure 7: Office Market Fundamentals by Year with Forecast

Source: Office, United States, CoStar Group Data, January 2024.

It is still too early to suggest that the office market has reached a consensus on pricing for the remote work model. However, two key differences stand out relative to last year: 1) enough time has now transpired to gain some clarity on emerging office trends, and 2) we are seeing that market clearing trades are starting to take place.

The downsizing trend continues. CoStar data reveals tenants signing smaller square footage leases than before the pandemic, around 20% less than the pre-pandemic average.²⁸ We believe this will continue in H1 2024 with the expectation that tenants will continue to right-size or press pause on expansion plans until the office market finds its footing.

We believe that the upcoming loan maturities are a significant factor that will continue to drive the price discovery for offices. According to Colliers and Mortgage Bankers Association, roughly 40.9% of office loans are maturing or have matured between 2023 and 2024.²⁹ Although more multifamily loans are expiring than office, one of the differences is that a higher average level of distress is anticipated for offices due to relatively weaker fundamentals. Given the massive disruption the sector has experienced since the pandemic, most office loans slated to mature in 2024 will likely be ineligible to refinance anywhere near their current outstanding debt levels. While some owners may opt for cash-in refinances and continue to hold, others will be forced to liquidate or return the keys to the lender. All this to say, the office sector has much reconfiguring ahead in a year where the sector also searches for its resetting base.

Figure 9: CRE Loan Maturities by Asset Class

Source: "Quick Hits | Loan Maturities are Here," Colliers, April 2023.

CrowdStreet’s Strategy

We see opportunity in the office sector as relatively straightforward. We will consider deals with market-clearing pricing for high-quality office properties in locations that we believe have a strong potential to recover during the upcoming real estate cycle. Even with a high level of scrutiny, we still see some office projects showing signs of market recovery, discounted prices, and recovering occupancy rates. Due to the inherent risk in the office sector today, we will consider projects with high cap rates or significantly discounted pricing in case of unknown factors that can hurt the project, meaning such projects may have the potential for a greater margin of error - this combination may provide the confidence we need to bring office deals to our Marketplace in the sector’s recessionary period.

We are skeptical when evaluating Class B and C office properties and projects that offer commoditized space, meaning fairly generic offices with limited amenities. Given the significant decline in prices across the sector, we believe that it is usually not justifiable to acquire what we consider to be substandard assets even if they offer additional discounts when compared to higher quality assets, particularly at this stage of the cycle. Since we anticipate that a certain portion of the office sector may not recover due to a trend away from obsolete offices and a flight towards quality, we believe that the values of assets in the bottom quartile will eventually settle at a discount to the land value.³⁰

In addition to the “why,” the “where” can also be an important factor to consider for the office sector. Markets vary significantly in their recovery and occupancy rates. For example, office properties with relatively strong occupancy rates and recent leasing momentum may offer a more viable opportunity than an office project in, let’s say, suburban Houston or San Francisco, which are seeing one of the most negative net absorption and vacancy rates above 22% and 34%, respectively.³¹In general, we will also review office utilization trends and submarket vitality when considering location.

24. “State of Remote Work in 2024: How to Navigate the Remote Job Market in the New Year,” LinkedIn, December 2024.

25. “The Cities With the Most Class B Office Pain,” GlobeSt, September 2023.

26. “Office Buildings Hardest Hit by Pandemic Share Common Characteristics,” CBRE, April 2023.

27. “2023 U.S. Real Estate Market Outlook Midyear Review,” CBRE, September 2023.

28. “US Office Leasing Picks Up, but for Smaller Spaces,” CoStar, August 2023.

29. “Quick Hits | Loan Maturities are Here,” Colliers, April 2023.

30. “The Flight to Quality Quantified,” CBRE, August 2022.

31. U.S. Office Figures, “Soft Office Market Fundamentals Persist”, CBRE, Q3 2023.