Brandywine Realty Trust CEO Jerry Sweeney doesn't consider himself an optimist when it comes to the end of the national office market's "frustratingly slow" slog. But even the head of one of the largest U.S. real estate investment trusts sees early signs of what he said could be a turnaround — or at least a clearer picture of where the market may be headed.
A steady pickup in leasing, a burst of steeply discounted sales, and hints from large institutional investors have combined in recent months to provide an improved outlook that commercial real estate stakeholders such as Sweeney say they haven't had since the COVID-19 pandemic's outbreak more than four years ago. There's little debate the market faces unprecedented challenges, but some developers, investors and landlords are edging forward.
"There are a lot of stress factors impacting our business, so sure, from that standpoint it isn't as rosy as we'd like," Sweeney told CoStar News. "But now we figure out our relative positioning in all of it, what opportunities that presents and how we can be aggressive in taking advantage of them."
Across the United States, commercial property leasing has fallen nearly 15% from its annual average in the years leading up to the pandemic. Arrested sales volume that afflicted various office markets for the past several years is beginning to settle into what some real estate professionals say could be a post-pandemic reality. Companies such as Kroger, UPS, Amazon and IBM have formalized return-to-office policies and are now more willing to commit to longer-term lease deals.
Smaller investors, lured by record-low prices and the chance to acquire properties previously out of reach, have closed a flurry of deals since the start of 2024 to help reset valuation expectations. And, while interest rates remain elevated, real estate professionals say the shock from the string of increases ended last year has since worn off, making it easier to map out a strategy for the year ahead with a bit more certainty.
"We've seen the worst from a capital markets perspective, and while we might not be at the bottom just yet, we're close to it," said Kevin Shannon, Newmark's co-head of U.S. capital markets, told CoStar News. "Rates went up so fast that you didn't know how high was high or what your cost of capital was, and that's scary. People have a better understanding now, and while the impacts from the pandemic means the healing process will take longer, there are more signs of certainty and we can at least now see the bottom and rebuild from there."
Even Blackstone, the world’s largest commercial property owner, called 2023 a cyclical bottom for commercial real estate and acknowledged the hard-hit sector may present some opportunities for the firm to dive back in after cutting its U.S. office exposure to just 1% of its global real estate portfolio.
The New York-based private equity giant is now looking to buy “super-high-quality” office buildings at depressed prices, Jonathan Gray, Blackstone’s president and chief operating officer, said at New York University Schack Institute of Real Estate’s recent annual REIT symposium.
To be clear, investment volume across the national office market is still at a low not seen since the likes of the Great Recession or the dot-com bust. But in the challenging sales landscape, Phil Mobley, CoStar Group's national director of market analytics, said a silver lining is that this cycle's investment activity appears to at least be near bottom.
Sales volume has plummeted by more than 55% over the past year to $35 billion, according to CoStar data, a nearly 15-year low. Yet, on a quarterly basis, sales activity held steady throughout 2023 and even ticked up in the early months of 2024 as significant discounts pushed an expanding group of investors to take advantage of more deals.
Leasing Gains Traction
For Brandywine's Sweeney, uncharacteristic optimism has emerged as tenant demand for office space recovers from its pandemic-era hibernation.
The Philadelphia-based real estate investment trust, overseer of a portfolio spanning more than 22 million square feet across Pennsylvania, Texas and the Washington, D.C.-area, reported tenant tour activity in the first few months of this year jumped nearly 50% compared to its previous quarterly average. More than half the deals the developer has signed at the start of the year are attributable to companies looking to "move up the quality curve," Sweeney said, trading spaces in older buildings for offices in newer ones.
Other developers and landlords, especially those with portfolios concentrated with properties on the higher end of the quality spectrum, are also reporting an uptick in tours and leases that, in some cases, echo activity seen before the pandemic. Boston Properties, one of the nation’s largest office landlords, reported its weighted average lease term had climbed to more than 11.5 years in the first quarter, the highest since COVID-19 disrupted the office market in 2020.
In New York, a market Newmark's Shannon said is the furthest along in its recovery from the pandemic, about 250 tenants are looking to sign on for roughly 22 million square feet of office space, according to data from the brokerage Raise. About 45% of that demand is being driven by companies in the financial services or legal industries, while about 17% of that is fueled by those in technology.
Vornado Realty Trust and SL Green Realty, Manhattan’s largest office landlord, both said on first-quarter earnings calls they have started to see a pickup in interest from the tech industry in New York after a quiet period.
And in Silicon Valley — an area dominated by tech giants that were quick to offload significant chunks of office space — more than 80 tenants are hunting for a total of more than 4.2 million square feet, according to Raise data. More than 3.1 million square feet of that is for space exceeding 100,000 square feet, signaling that a growing pool of tenants are once again willing to commit to large spaces after several years of dramatically shrinking their real estate portfolios.
The turnaround in leasing follows several years of companies trying to figure out where and how employees want to work — and how much space they actually need to accommodate those shifts.
That is now beginning to settle, Gensler co-chair Diane Hoskins told CoStar News, meaning companies are now more willing to invest in high-quality spaces to try to make their offices destinations worthy of a commute, not a daily obligation.
"There is more certainty and clarity about the value of workspaces," the architecture firm executive said. "We're heading toward an equilibrium where tenants are still looking for value but are also willing to invest in premier buildings that are helping to make it easier getting employees to want to come back to an office. A lot of dynamics have changed, and companies have far more confidence in decision-making now."
Some tenants are committing to office space for the long term, even if it is for less than what they previously occupied. Tenants collectively signed on for about 395 million square feet last year, according to CoStar data, about 13% below the annual average reported in the years leading up to the pandemic's 2020 outbreak. What's more, those deals are about 16% smaller on average than those signed between 2015 and 2019, exacerbating the vacancy challenges and the available space across the country's largest office markets.
Hunting for a Deal
After years of tabling some deals or sticking to the sidelines, a growing pool of private buyers, owner-users, local firms and smaller asset managers are scooping up properties at a fraction of their previously traded prices, helping to provide some clarity as to where valuations are ultimately expecting to settle.
Large institutional firms such as Blackstone, Clarion Partners and Brookfield are still selling properties at discounted prices and have yet to return to the market as buyers. However, Shannon said more are now talking about jumping back in compared to this time last year.
"Institutions typically come in after the market has clearly bottomed," he said. "They're more conservative than other buyer types, but last year almost none of them were looking at office and this year, they're discussing it. That's not to say they're buying yet, but there's progress in the fact that they're looking again."
A joint venture between New York Life Real Estate Investors and investment firm Bridgeton, for example, earlier this month closed a $22 million deal to acquire 410 Townsend St., a 78,000-square-foot office building in San Francisco's tech-concentrated SoMa area that has a long history of housing early-stage startups. The building last sold in 2019 when seller Clarion paid nearly $86 million, and this deal underscores the growing eagerness among investors in getting in on the ground floor of cities' post-pandemic recoveries — and fear in missing out on a major deal.
"This is the start of the recovery for the San Francisco real estate market," Albert Pura, New York Life Real Estate Investors' senior director of transactions, said in a statement. The Townsend Street building offers the joint venture “the opportunity to acquire a best-in-class” building at a significant discount, a sentiment echoed among other buyers behind deals that have recently closed in top-tier markets such as San Francisco, Boston, Chicago, Los Angeles, New York and Washington, D.C.
There is still plenty of uncertainty stemming from issues such as sticky inflation and ongoing job cuts, all of which could derail what some office stakeholders say they hope are early signs of a market rebound.
Cyrus Sanandaji, the co-president and CEO of real estate investment firm Presidio Bay Ventures, said any sense of optimism in the broader office market will also need to be broken down on a market-by-market level given each region's specific set of both challenge and opportunities.
"I wouldn't paint the entire U.S. office market with a broad stroke [since] there's so much nuance that will impact the recovery of each market," he said. "However, in general, the increasing pushback against remote work in most creative and apprentice-based industries is very promising."
The firm last year was one of the first investors to close an office deal since the early days of the pandemic, acquiring the building at 60 Spear St. for about $41 million, or less than one-third of the property's previously sold price tag.
Presidio Bay, continuing to focus on opportunistic deals downtown, is now in the early stages of putting together plans to invest another roughly $4 million to overhaul the Spear Street property into an "office resort," building in hospitality minded amenities such as a rooftop bar and restaurant, sauna rooms, cold and warm-water plunges, saltwater floating pools, and spaces for both coworking and events.
The CEO said he's mindful of the challenges that still face the city and its record amount of available office space, but the chance to position the firm and its portfolio at the forefront of what he said is "a true urban renaissance" is worth the financial risk.
"In San Francisco specifically, we’re seeing the entire ecosystem, from investors to entrepreneurs, embrace the return to office and recognize how much you gain" from being back in a physical space, he said. "This is what’s driving so many to start searching for office space and signing new leases. We need a lot more of it, but when it turns back on, it’ll ramp up very quickly and beyond what most people are anticipating.”