The seeds of a broader office market recovery are beginning to sprout as landlords report a resurgence in tours and negotiations that are beginning to translate into long-term commitments.
After years of scrambling to backfill large tenant downsizings and terminations, executives of Los Angeles-based real estate investment trust Kilroy Realty said demand across its West Coast portfolio has hit a level to help push it back in the black, pointing to strengthening leasing activity among tech tenants that until now were more focused on shedding rather than taking on additional space.
CEO Angela Aman told analysts Kilroy has seen "a meaningful acceleration in tour activity" this year "off a very low 2023 base," as the firm "navigates a challenging but steadily recovering operational environment."
"Over the last two to three months, we've seen a crystallization of this demand as tour activity has expanded to include a much wider range of potential tenants, and these tenants appear more prepared to execute," Aman said on the developer's latest earnings call.
The landlord reported a slight uptick in occupancy during the third quarter, when it signed roughly 436,000 square feet in deals, notably with major tech companies SAP and NVIDIA. Since the start of the year, Kilroy has collectively signed nearly 1.1 million square feet of office deals, almost on par with the roughly 1.35 million square feet it signed last year.
However, for all of the renewed optimism of a widespread rebound, large office landlords still have ways to go in regaining their pre-pandemic footing.
Return of the larger tenants
The national office vacancy rate, fueled by companies offloading record amounts of sublease space and responding to the effects of remote work, has climbed to nearly 14%, according to CoStar data. Tenants collectively handed back upward of 65 million square feet last year, boosting the total to more than 180 million square feet of move-outs since the start of 2020.
What's more, the number of leases signed in recent times has shrunk considerably, averaging about 20% smaller than pre-pandemic averages.
For Kilroy, the Southern California firm is focused on boosting occupancy across its portfolio, which has ticked up slightly to settle at nearly 84.5%. While some areas in San Diego and Silicon Valley are nearly full, Aman said some of the firm's properties in San Francisco, Los Angeles and Seattle have some ground to make up.
But Kilroy is seeing signs of a broader resurgence. In the Seattle area, for example, momentum is building and will continue to climb as major employers like Amazon escalate in-person requirements, Aman said.
"This is a sign of things to come," Aman said. "We're seeing tenants who had reduced space or were actively planning on reducing space in 2025, come back and sort of begin conversations with us because they believe they've overshot those reductions. Now that they're getting people back into the office more consistently, they have a better sense of what their ultimate utilization of real estate requirements are and are realizing that they're a little bit different."
In the San Francisco Bay Area, Kilroy is betting the region's hotbed of fast-growing artificial intelligence companies will continue to be a significant catalyst for the region's office market recovery, the CEO said.
'Additive' opportunities
While voicing their optimism is one thing, larger REITs and landlords' return to capital markets is more telling of their confidence in the national office sector's rebound.
Cousins Properties, for example, recently paid more than $80 million for a trophy office tower in midtown Atlanta, making good on a promise CEO Colin Connolly issued over the summer to take advantage of "compelling investment opportunities" to expand the landlord's portfolio.
Boston's BXP shed light earlier this week on plans to take advantage of depressed valuations, with the goal of building out its portfolio of high-end office properties in some of the nation's most expensive office markets.
For Kilroy, it meant scooping up the Junction at Del Mar, a two-property portfolio deal in San Diego the landlord purchased for $35 million. The buildings, collectively 96% occupied at the time of the September deal, is next door to the developer's 1.4 million-square-foot One Paseo mixed-use project.
"This really checks so many boxes for us as an acquisition," said Jeffrey Kuehling, Kilroy's chief financial officer. "We know the market incredibly well. We know the micro location very well. Having so much scale next door allows us to take advantage of that. And the more we can do to extend that brand and integrate adjacent properties, we think is very additive."