By Craig Barbarosh, Senior Managing Director and Jake Henning, Managing Director of CommonWealth Partners LLC
Commercial real estate’s office sector is currently the “haves” versus the “have-nots.” We project a shortage of space in best-in-class central-business-district (CBD) office assets with the best amenities, while there will continue to be excess supply of lower-quality and suburban office spaces that will need to be repositioned for alternative uses.
Return-to-office policies are accelerating, and employers want to offer premier office environments to entice their employees. National vacancy and sublease availability appear to have peaked,[2] construction starts are at historic lows in the current market,[3] and transaction volume is well below historical levels.[4] Nearly $400 billions of office loans are maturing in the next three years,[5] and most loans face significant funding gaps estimated at $130 billion for office secured loans.[6] As a result, we see challenging, capital-intensive workouts ahead for most office loans, yet higher demand and pricing with limited supply for best-in-class office assets.
Office Market Fundamentals
National vacancy in the broad office sector appears to have peaked and is currently at 18.9 percent, which is 10 basis points lower than a year ago. [7] Sublease activity continues to decline and is currently 80 basis points below peak, [8] and construction starts [9] and completions [10] are at all-time lows while replacement costs are at all-time highs. [11]
Office inventory removals (conversions/demolitions/etc.) are at all-time highs and trending at three times historical averages. [12] Leasing volumes have increased across all tenant industries and are currently trending at a 10-year average, which represents 90 percent of pre-COVID volume. [13] Large office occupiers are experiencing a shortage of available high-quality space. In New York City, for example, 2024 saw more $100/square foot leasing transactions than in any prior year in history, [14] generally concentrated in the premier subset of buildings, and net effective rents for premier assets increased by 5.2 percent in 2024. [15] Premier CBD vacancy is expected to return to the pre-pandemic rate of 8.2% by 2027. [16] Return-to-office policies are accelerating, and employers are being more aggressive in their policy enforcement. Many large employers now require five days per week in the office,[17] and 78 percent of Fortune 100 companies require in-office work averaging 3.4 days per week. [18] Net absorption of office assets has been positive for three consecutive quarters. [19]
The story is different for suburban markets and lower-quality office assets in all markets. Employers are opting for high-end buildings with modern amenities, leaving so-called B-quality buildings struggling to find tenants or pursue repositioning.[20] In New York City alone, there are currently 15 million square feet of office buildings that are in the process of being converted to residential projects.[21] Net absorption among premier and non-premier office assets has varied dramatically since 2020, with the premier subset indicating 57.5M square foot positive absorption compared to negative 163.7M square foot in the non-premier subset. [22] This dynamic highlights the “flight to quality” trend among tenants.
Office Capital Markets Overview
Equity capital for office investment remains very limited in the current market and tends to be focused primarily on smaller assets (<$150 million), opportunistic/value-add risk profile and premier quality assets. Private-equity fundraising in 2024 was at its lowest level since 2012, [23] and domestic pension funds currently have limited allocations for new office investments. Debt markets remain constrained but are improving with a primary focus on high-quality core office product.[24] CMBS lending increased in 2024 after a period of very limited activity, with several notable SASB transactions closed in the office sector.[25]
Borrowing costs have improved slightly as spreads tighten for senior tranches. [26] Lenders have been reluctant to enforce remedies against office borrowers over the past few years, but they are increasingly less willing to be overly accommodative to borrowers. Approximately 80 percent of distressed commercial mortgages have been restructured or remain in default,[27] and near-term office loan maturities have increased by $134 billion, with nearly $400 billion in maturing office loans in the next three years[ 28] with a projected funding gap of $130 billion. [29]
CMBS office delinquency rate is currently 11 percent.[30] As a result, office transaction volume remains at historic lows [31] but is anticipated to increase in 2025 as owners and lenders are faced with increasing pressure to address capital structure, liquidity needs and challenging fundamentals.
What Happens Next
The near term will present challenging times for undercapitalized, over levered owners of office assets and their lenders. Borrowers and lenders are facing weak operating fundamentals, deteriorating cash flow, accelerating capital requirements, continued elevated borrowing costs, declining valuations, and scarcity of debt and equity capital for office assets. Leveraged owners and their lenders will continue to struggle to recapitalize distressed office assets, which will accelerate defaults and short sales. The limited capital and resources available will be focused predominantly on the premier assets in the markets with the highest tenant demand and best opportunities for asset repositioning.
Lower-quality assets in all markets and suburban office assets across the country will face increasing challenges for repositioning and de-levering. Certain markets and assets will offer some opportunity for residential conversion, but the majority of lower-quality office assets will continue to suffer without feasible alternatives. The best office assets in the most attractive submarkets will continue to perform well and have access to capital, while the rest of the market will continue to suffer and result in increased loan workouts, foreclosures and short sales.
[2] CBRE Econometric Advisors Data, Q4 2024.
[3] “U.S. Office Market Dynamics,” JLL Research, Q4 2024.
[4] Real Capital Analytics Data, Q4 2024.
[5] “State of the U.S. Capital Markets,” Newmark Research, Q4 2024.
[6] “Maturity Extensions Obscure Office Debt-Funding Gap,” CBRE Econometric Advisors, Feb. 6, 2025.
[7] CBRE Econometric Advisors Data, Q4 2024.
[8] CBRE Econometric Advisors Data, Q4 2024.
[9] “U.S. Office Market Dynamics,” JLL Research, Q4 2024.
[10] CBRE Econometric Advisors Data, Q4 2024.
[11] Turner Cost Index, Q4 2024.
[12] “U.S. Office Market Dynamics,” JLL Research, Q4 2024.
[13] Costar Data, Q4 2024.
[14] “New York Analysis of Top Tier Transactions,” JLL, Year-End 2024.
[15] “Top-Tier Office Rents Continue to Rise, While Lower-Tier Rents Fall,” CBRE Econometric Advisors, March 5, 2025.
[16] CBRE Real Estate Forecast.
[17] Large employers that require five days per week in the office include Boeing, JP Morgan, The Washington Post, Goldman Sachs, Citibank, Stifel and Equifax.
[18] “U.S. Office Market Dynamics,” JLL Research, Q4 2024.
[19] CBRE Econometric Advisors Data, Q4 2024.
[20] New York Post, April 16, 2025.
[21] Yardi Matrix Data, 2025.
[22] CBRE Econometric Advisors Data, Q4 2024.
[23] “FY 2024 Fundraising Volume Down 50% From Peak,” PERE, Jan. 9, 2025.
[24] “Commercial Real Estate Monitor: Optimistic Sentiment Despite Growing Distress,” Goldman Sachs Credit Strategy Research, Jan. 30, 2025.
[25] “State of the U.S. Capital Markets,” Newmark Research, Q4 2024.
[26] “State of the U.S. Capital Markets,” Newmark Research, Q4 2024.
[27] “Commercial Real Estate Monitor: Optimistic Sentiment Despite Growing Distress,” Goldman Sachs Credit Strategy Research, Jan. 30, 2025.
[28] “State of the U.S. Capital Markets,” Newmark Research, Q4 2024.State of the U.S. Capital Markets,” Newmark Research, Q4 2024.
[29] “Maturity Extensions Obscure Office Debt-Funding Gap,” CBRE Econometric Advisors, Feb. 6, 2025.
[30] “Maturity Extensions Obscure Office Debt-Funding Gap,” CBRE Econometric Advisors, Feb. 6, 2025.
[31] Real Capital Analytics Data, Q4 2024.
Links:
[1] https://www.abi.org/terms/committees/real-estate
[2] https://www.abi.org/terms/journal-article-tags/real-estate
[3] https://www.abi.org/print/1000698 5/6
https://www.commonwealth-partners.com/
[4] https://www.commonwealth-partners.com/
