Office demand beginning to stabilize
After five quarters of declining demand, most U.S. markets are beginning to see an increase in total office occupancy, though the sector is not out of the woods yet.
According to CoStar, more office tenants are holding onto their space than in previous years, as return to office mandates continue to rise. While the largest cities are still struggling to retain office tenants, the nation’s secondary and tertiary markets have posted 4.8 million square feet in positive absorption.
Recent absorption trends have been supported by owner-occupiers, who moved into nearly 8 million square feet in the past year and now account for an increasing share of office building buyers. In addition, warm-weather areas that experienced migration during the pandemic, such as South Florida, Jacksonville and Houston, are leading the nation in office-using job growth.
Conversions to accelerate
Meanwhile, total office occupancy remains more than 213 million square feet below its level in early 2020 (pre-pandemic), and those spaces are unlikely to backfill soon. One solution is to begin converting less-competitive office space in high-value locations to multi-family housing or other uses.
Successful projects can transform neighborhoods, especially in markets where housing is scarce. However, the cost of financing the reconstruction of office buildings is closely tied to interest rates. High borrowing costs could narrow the number of office conversion candidates capable of generating attractive returns.
Redevelopments also depend on the level of acceptable investment risk. Many owners of underperforming office buildings may be forced by their lenders to dispose of buildings at low prices. However, other building owners are expected to hold on to their properties as long as they can, taking advantage of loan modifications and waiting for lower rates or improving market conditions to make them whole.
