Towering prospects
Offices continue to be plagued by high vacancy rates (20.1% in this year’s third quarter, per Moody’s), the bedeviling result of the work-from-home mindset that the pandemic created. In 2019’s fourth quarter, it was 16.8%. Also not helping: Some places have an over-abundance of office space, which brings downward pressure on leasing profitability.
But guess what? The outlook for the battered office sector is promising, and some investors are taking notice amid bargains. Just look at the performance of real estate investment trusts specializing in the office sector: Their stocks have gained 28.5% this year, according to industry group Nareit, and are outperforming the bouyant S&P 500 by a couple of percentage points. In 2023, the Nareit office index increased just 2.0%, when the S&P 500 rose 26.1%, almost as much as it has this year.
Michael Acton, the well-regarded head of AEW Research, an investment manager, pooh-poohs the notion of an “urban doom loop” that has unsettled office investors in the recent past. In an interview, he points to leasing upticks in Boston and New York, and argues that good times lie ahead for the office market and investors who plug money into it now.
We’re not talking about some overnight turnaround. This recovery will be a gradual process, which offers opportunity to patient investors. Vacancies “are not getting any worse,” Acton notes. “We’ve reached a new equilibrium.” Leasing activity is up, says real estate services firm JLL, growing 0.4% in this year’s third quarter, compared with the prior period.
Furthermore, office real estate “is cheap,” Acton says. “It’s as cheap as it has been in 10 years.” Net absorption, which measures occupancy growth, expanded 10% in the third quarter, by JLL’s reckoning, a turnaround from its previous shrinkage. Few new office buildings are under construction, which buoys the results. Currently, just 50.3 million square feet are “in the active development pipeline, the lowest total since the Great Recession,” states real estate firm Colliers, in a report. Lower supply will be a tonic for prices.
Another factor aiding offices: Some businesses are doing away with remote working, notably financial firms. To be sure, the popularity of a partial week at home remains robust, making office appearances more palatable. “Tuesday, Wednesday and Thursday in the office are what most people want,” Acton says.
As a result, it stands to reason that, absent an economic downturn-linked corporate downsizing, the amount of office space needed will not shrink. Employers will need the same amount of space for Tuesday-Thursday office occupants as they did for the mandatory Monday-Friday ones of yore. And the finance crowd will be in their workplaces all week long.
Certainly, there are office buildings and there are office buildings. The newer structures command the most popularity. A dumpy old dust bucket with creaky elevators and bland interiors offers little appeal nowadays. “People want more light, more collaborative space, kitchens, athletic areas,” Acton says.
Net-net, though, things are looking bright ahead. Acton spotlights the last time offices were in a bad way, especially in cities, the 1970s. Offices went on to boom in the 1980s. Says Acton, “Those buildings were bargains in the 1970s and investors made a lot of money from them.”
