The office real estate sector, grappling with stubbornly high vacancy rates of 20.1% in the third quarter of this year, a lingering consequence of the pandemic-induced work-from-home trend, presents a compelling investment opportunity for those willing to take a long-term view. While the current vacancy rate is significantly higher than the 16.8% recorded in the fourth quarter of 2019, and while an oversupply of office space in certain markets continues to exert downward pressure on leasing profitability, several factors point to a promising future for this beleaguered sector. The impressive performance of real estate investment trusts (REITs) specializing in office properties further underscores this positive outlook. These REITs have seen their stock values surge by 28.5% this year, outpacing even the robust S&P 500 index. This starkly contrasts with the previous year, where the Nareit office index grew by a mere 2.0% compared to the S&P 500’s impressive 26.1% gain.
Contrary to the “urban doom loop” narrative that has recently plagued the sector, experts like Michael Acton, Head of Research at AEW Capital Management, foresee a brighter future. Acton highlights positive leasing trends in key markets like Boston and New York, suggesting that the tide is turning. While acknowledging that a full recovery will take time, he emphasizes that the situation is stabilizing, with vacancy rates holding steady and leasing activity experiencing a modest uptick. This gradual recovery creates an advantageous environment for patient investors seeking value opportunities. The real estate services firm JLL confirms this trend, reporting a 0.4% increase in leasing activity in the third quarter of this year compared to the previous quarter.
The current market presents a particularly attractive entry point for investors due to historically low office real estate prices. Acton underscores this point, noting that prices are currently at their lowest levels in a decade. This affordability, combined with increasing occupancy growth, as evidenced by a 10% expansion in net absorption in the third quarter according to JLL, strengthens the case for investment. Furthermore, the limited construction of new office buildings, with the lowest total square footage in the active development pipeline since the Great Recession, according to Colliers, further supports the prospect of rising prices and improved returns for investors. This constrained supply dynamic is a crucial factor in bolstering the long-term outlook for the office sector.
Several factors are converging to support the recovery of the office market. One notable trend is the reversal of remote work policies by some companies, particularly within the financial sector. While the preference for a hybrid work model remains strong, with most employees favoring a Tuesday-Wednesday-Thursday in-office schedule, this still translates into consistent demand for office space. This suggests that, barring a significant economic downturn leading to widespread corporate downsizing, the overall demand for office space will likely remain stable. Companies will require comparable amounts of space to accommodate their employees on their in-office days as they did for the traditional five-day workweek. The full-time presence of the financial sector further bolsters this demand.
However, the current office market is not monolithic. The demand for office space is heavily influenced by the quality and amenities offered. Modern buildings with desirable features such as ample natural light, collaborative spaces, well-equipped kitchens, and fitness areas are highly sought after, while older, less appealing buildings struggle to attract tenants. This dynamic underscores the importance of investing in properties that cater to the evolving needs and preferences of today’s workforce. The current market dynamics favor well-maintained and updated properties offering attractive amenities that enhance the employee experience.
Despite current challenges, the long-term outlook for the office sector appears promising. Drawing parallels to the office market downturn of the 1970s, which was followed by a significant boom in the 1980s, Acton suggests that the current market presents similar opportunities for savvy investors. The discounted prices of office buildings today create the potential for significant returns in the coming years, mirroring the successful investments made during the previous downturn. This historical precedent offers a compelling argument for considering investment in the office sector, particularly for those with a long-term investment horizon.
