2024 Mid-Year Office Market Outlook for Corporate Tenants

In this article, you'll discover:

• How high vacancies and low demand are driving down office property values.
• The increasing trend of landlords handing back keys due to non-viable properties.
• The challenges and limitations of office-to-residential conversions.
• How corporate tenants can leverage current market conditions for favorable lease terms.

The office market appears to be in a state of flux, constantly reorienting to avoid a post-pandemic crash.

High vacancies and low occupancy rates steal most of the headlines when it comes to the office discussion.

However, beneath the surface, there are a lot of moving forces further shaping the market. The ever-changing hybrid work debate, the push for office conversions, and the demand for quality workspaces all play a part in the future of office space.

So, to stay on top, it’s critical to be aware. One must look critically at the trends dominating the first half of the year in order to strategize for the months and years ahead.

Because for corporate tenants, under what appears to be a chaotic, dysfunctional market, lies the lease deal of a lifetime.

So, let’s dive in and discuss the mid-2024 outlook for office tenants. Properly leveraging your knowledge could be the key to slashing your overhead costs and setting up optimal long-term roots.

For a full discussion on how to survive the post-pandemic office market, download your free copy of Surviving the Office Apocalypse. 

Property Values are Down

The momentum for returning to the office has plateaued. Despite the push for in-person work, many companies have discovered that productivity remains robust with full- or part-time remote schedules.

This revelation has fundamentally altered the traditional view of the workplace as indispensable to business operations, a shift reflected in occupancy rates hovering around 50%.

As the value of office space plummets, the urgency to cut costs and enhance financial performance has become a powerful driver for companies to reduce their office footprints.

Enter the strategic phenomenon of Right-sizing, where businesses are shedding surplus office space. This maneuver has marked a significant and likely irreversible evolution in how businesses operate.

Consequently, even when leases are renewed, they often involve smaller, Right-sized spaces, pushing office vacancy rates to unprecedented heights. Note the skyrocketing national office vacancy rate since the pandemic.  

High availability and low demand have done serious damage to office property valuations.

Morgan Stanley Capital International (MSCI) reported that the average price per square foot for office sales in the third quarter of 2023 dropped by 11.1%, settling at an average of $220 per square foot.

The $10.6 billion in office sales during the third quarter represented the lowest volume since the first quarter of 2010.

High Interest Rates Stall New Developments

On top of this, relentless interest rates have put more pressure on property owners' capacity to refinance existing loans or secure new financing. This challenge is further eroding property values and dampening the overall vitality of the commercial real estate market.

The domino effect continues as the reduction in affordability due to higher interest rates contributes to a slowdown in property transactions, diminishing demand. This current climate has driven investment in speculative developments to a halt, raising questions about future supply if the market evens out.

Investopedia reports that office construction has fallen by more than half since 2020. The stark numbers reveal a 5.3% decrease in office space under construction in the fourth quarter, adding to the narrative of a market grappling with instability.

Interest Rates Prolonging Fire Sales

Despite all the talk of distress and rapid devaluation, sales of distressed properties have remained relatively rare so far. Some stakeholders are delaying decisions, hoping for office demand or other economic conditions to stabilize.

Meanwhile, another phenomenon at play is "extend and pretend." Lenders are widely extending the maturity dates of office loans or modifying terms, such as reducing interest rates or temporarily lowering payments, to help borrowers avoid default or foreclosure in the short term. This strategy aims to provide borrowers with additional time to improve their financial situation or wait for market conditions to become more favorable, effectively "pretending" that the underlying issues will resolve themselves.

However, this approach can also delay the resolution of financial problems and potentially lead to larger losses for lenders if the issues persist or worsen.

With another wave of loan maturities looming, there's only so much extending and pretending that can happen before we face a harsh reality check.

Landlords Handing Back the Keys

And on the other end of the spectrum, landlords are resorting to another strategy for economically unviable properties: handing the keys back to the banks. Given that commercial loans are often non-recourse, many landlords are opting to walk away from further liabilities. In these situations, the captain is certainly not going down with the ship. Instead, property owners are reevaluating where to allocate their equity and are increasingly inclined to invest in the Sunbelt, rather than pouring more good money after bad investments.

Urban Dystopian Spiral (UDS Syndrome)

Towards the end of 2024 and into 2025, one of the most significant trends affecting the office and commercial real estate market is the phenomenon known as the Urban Dystopian Spiral (UDS Syndrome). This term describes the cascading and self-reinforcing decline triggered by an excess of vacant commercial properties, which has far-reaching impacts on urban ecosystems.

The initial concern is the surplus of vacant office buildings and commercial spaces. This oversupply not only affects commercial landlords struggling to fill their spaces but also initiates a broader economic and social decline in urban areas.

With insufficient corporate tenants, the demand for surrounding and supporting retail establishments, such as restaurants and convenience stores, diminishes significantly. This drop-in commercial activity results in lower property values, which in turn reduces the assessed value of properties.

Decline in Property Tax Revenue

A significant consequence of falling property values is the reduction in municipal income from property taxes. Lower property tax revenues strain city budgets, hampering their ability to maintain essential public services. This deterioration in public services can lead to a noticeable decline in the overall quality of life in urban areas, making them less attractive to both residents and businesses.

The Rise of Crime 

As public services decline, crime rates tend to rise, further exacerbating the Urban Dystopian Spiral. Increased crime can deter businesses and residents alike, creating a vicious cycle of decline.

Given these deteriorating conditions, corporations are increasingly looking to relocate to states and cities that offer a more stable and attractive environment. Thus, we are seeing huge waves of retail closings. And as they pull their money and presence, this further decimates challenged areas, leading to blighted office parks or urban settings. 

Office Conversions are Still Too Expensive

Even though property values are hitting record levels due to even higher vacancies, the value of offices needs to decline even more precipitously for office-to-residential conversions to be even near considered realistic.

Transforming offices into housing is far too expensive to be the panacea for cities suffering with low occupancy. 

Our sources estimate that the cost for conversion per square foot could lie between $300 and $700 per square foot. To cover such high costs, developers will need to build expensive, luxury residential units.  Additionally, the overall square footage of office buildings may actually have to be reduced to allow for more light and ventilation. So, the cost per square foot will go up even more. 

And this cost comes because an overwhelming majority of office layouts are not conducive to becoming apartments. Challenges include: 

• Complying with housing requirements for lighting and ventilation 
• Transforming an office’s large floor plates into individual dwellings 
• Accommodating multiple new units and bathrooms with extra sewage 
• Trenching into floors to ensure plumbing functions appropriately without compromising the building’s structural integrity

So not only are there prohibitive costs and a massive construction undertaking, but working around challenges with zoning approval is not an easy process. 

While conversions are being suggested more and more to solutions to the office vacancies and affordable housing crises, they will not be more common until the value of office space drops further.

Urban Revitalization? Look to the Flight to Quality

At the same time, it is notable that Class A and Trophy office buildings are experiencing high demand. That is because well-healed corporations that want to increase in-office participation are competing with their space. 

In fact, any recovery the post-pandemic office market in Manhattan has shown seems to be primarily driven by an ongoing shift towards high-quality properties.

The price for premium properties is steadily growing while outdated properties are rapidly losing interest and largely sitting vacant. 

Because while property values are dropping an average 11% value in sales, there are also standout locations where went goes for $300 psf. In this case, we're talking about 1 Vanderbilt. The massive Manhattan tower sits above Grand Central Station and boasts premium amenities with a world-class chef on staff.  

On the other end of the spectrum, or outdated buildings are increasingly becoming stranded assets. In turn, metros with a higher concentration of Class B or C assets will be in for more of the UDS Syndrome.  

More Return to the Office

Despite the prolonged allure of hybrid work, some industries are calling for employees back into the offices. And while many sectors aren’t willing to give up remote flexibility, a new wave of employees returning to work could provide the office market with a trickle of steady demand that it needs.

Wall Street Power Houses J.P. Morgan and Goldman Sachs are calling their people back to a 5-day in person work schedule. Other big names like Boeing and UPS have enforced the same.

However, there is still pushback and the reluctance of employees to return on even a hybrid basis, has reinforced the importance of quality amenities in a workplace, thus making it a place that employees want to frequent.

Interestingly enough, the idea of reducing the commute is also why properties like 1 Vanderbilt demand such lofty rent premiums. The office space is located above Grand Central, one of the most major commuter ports in the Northeast.

The goal of reducing commute time is also why we’ve been observing the rise of live-work-play communities.

Mixed-use properties are incredibly popular among companies and employees. It is certainly a novel approach, but one that has performed well in the South. Translating the communal feel of live-work-play developments would bring an interesting yet promising approach to renew urban centers while reclaiming lost foot traffic and economic stimulus lost to zombie buildings. 

Tenants Can Take Advantage of Negotiation Leverage

The current real estate market dynamics are notably favoring tenants over landlords. An abundance of vacant properties has given tenants significant leverage in negotiations. This shift is evident as businesses seeking to lease or purchase properties capitalize on these market conditions. They often benefit from fire-sales and favorable terms, a result of the high supply and comparatively low demand.

Landlords, facing record vacancies, are increasingly compelled to accept reduced returns. To attract new tenants, they are offering more generous terms, such as lower rent rates and enhanced concessions. One prominent concession that has evolved to become more attractive is the tenant improvement allowance. This allowance, already a key negotiating point, is now being sweetened to make leasing more appealing to corporate tenants.

In this tenant-friendly market, it's more crucial than ever for tenants to conduct thorough due diligence. With an abundance of options available, tenants must carefully weigh their choices to identify the best opportunities, many of which they might not even be aware of. This makes it essential to work with an unbiased expert like a true tenant representative.

A tenant representative, well-versed in market dynamics, can provide valuable insights and guidance. They are equipped to act on behalf of tenants, ensuring they secure the best possible lease terms. By leveraging their expertise and understanding of the market, tenant reps can navigate the complexities of current conditions and negotiate favorable deals, optimizing the benefits for their clients.

Receive the blueprint straight from the True Tenant Rep™ experts on how to skilfully navigate this new era of office leasing and come out on top with your most advantageous lease. Download your copy of Surviving the Office Apocalypse today!