BXP chief says the office sector is overbuilt

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The US office market has been in crisis since the beginning of the pandemic, when workers were first ordered to return home. Some, especially younger workers, never returned, leaving many office buildings half-occupied or empty.

However, the overall office vacancy rate fell 20 basis points in the third quarter to 18.8%, according to CBRE. While this is still historically high, it marks the first year-over-year decline in vacancy since the first quarter of 2020, when Covid took hold in the US

According to the report, leasing activities exceeded the five-year quarterly average last quarter, driven by financial services and technology companies. The construction pipeline has also fallen and is on track for its lowest annual total in more than a decade.

“I definitely think we’ve hit bottom. I think we’ve hit bottom in 2024,” said Owen Thomas, CEO of BXP (formerly Boston Properties), the largest office REIT in the U.S. “There’s a lot of positive things going on in some, but not all, of the office business.”

One of these positive aspects is low interest rates. Capital is moving back into office real estate, Thomas said, starting on the debt side, where there’s a lot of large debt securitizations. He said BXP had just completed single-asset securitizations of high-end office buildings in New York City and Boston.

BXP invests almost entirely at the top end of the market, and many of its tenants are in financial and legal services. Thomas said that’s another positive. Financial services firms are seeing huge earnings growth, thanks in part to artificial intelligence. These firms also tend to use their own space more than others.

“These leading companies want to bring their employees back to the office, and of course they can mandate it, but what they really want is for their employees to want to come back to the office,” Thomas said. “That’s why you see the bifurcation in the office business between quality buildings leased by leading companies and the rest that are not performing as well as what we call the leading workplace segment of the industry.”

This “premium” tier is roughly defined as the top 10% of buildings. The vacancy rate in these buildings is much lower than the rest of the market, Thomas said, adding that the average in the cities where BXP operates is 11%, and asking rents in these markets are 55% higher.

But Premier buildings are not always new buildings. These are also buildings in desirable locations, especially those with easy access to public transportation. Landlords of second-tier buildings have also made a new move to compete with so-called Class A properties.

“There are a lot of office landlords today who have this strategy: We’re not trying to be the top tier workplace provider, we’re trying to be the top B building provider,” Thomas said. “They’re fixing up their buildings. They’re providing some of those amenities and providing a more value-oriented price point. So I think a lot of the demand will go to that.”

He added that BXP was not particularly interested in purchasing these buildings. Instead, it is pouring investment capital into new development, recently launching a $2 billion project at 343 Madison Avenue in New York City. Even though construction times are long, Thomas said the resulting efficiency is much better than existing, even affordable, buildings.

As for Mayor-elect Zohran Mamdani’s impact on the city’s real estate, Thomas is cautiously optimistic.

“Our success in any community is limited by the success of our community, so if the city doesn’t succeed, we don’t succeed. We want to do what we can to help him understand some of the things he promised as a candidate,” Thomas said, specifically noting housing affordability and public safety. he said.

“I’m not sitting here and saying I think this is necessarily going to be a positive, but given the approval rights that the state has on a lot of things and some of the early decisions that I’ve seen him make, like reappointing the police chief, I think some of those make us feel constructive about what that outcome might look like,” Thomas said.

He said New York City points to leadership in office conversions as a model for other cities and that the deals work financially because rents are so high. New York also introduced a tax incentive for developers, which Thomas called encouraging.

As for the rest of the country, conversions won’t solve the office vacancy problem, Thomas said.

“The office market in general is overbuilt. There will be buildings that will be demolished and converted into something else. We’re doing some of that in suburban areas,” Thomas said. “But transformation, when people get into this, they think that’s going to be the answer.

“This will be an answer. This is not an answer,” he said.