The report: A new working order: Reimagining offices in a hybrid world
Source: Moody’s
Why we picked it: With vacancy rates at historic highs and traditional work patterns in flux, banks must understand new market shifts in order to make informed lending decisions and manage risk effectively. The latest from Moody’s delves into emerging trends such as the suburban office revival, the impact of AI on space demands and the potential for adaptive reuse projects. By exploring these developments, bankers can better assess the viability of office properties, adjust their underwriting criteria and identify new opportunities in the changing CRE market.
Executive Summary
The U.S. office vacancy rate has soared to a record-breaking 20.1%, a startling shift that’s reshaping cityscapes across America. This unprecedented figure, which represents some 902 million square feet of empty office space (equivalent to about 300 One World Trade Centers) paints a stark picture of an industry in flux.
The Covid-19 pandemic of course acted as a catalyst, emptying downtowns and suburban office parks. But, a nuanced picture has emerged from the settled dust. Where some predict the death of the office, other savvy observers see a sector poised for reinvention.
Key Takeaways:
- U.S. office vacancy rate hits historic high of 20.1%, with 902 million square feet standing empty.
- Suburban offices are outperforming central business districts in many markets.
- Class A properties and renovated spaces are showing resilience, while older Class B and C buildings struggle.
- Adaptive reuse and conversions may help balance the market in the long term.
Why we liked it: Excellent graphics and visual display to represent some strong data. When a quick turnaround is often prioritized over quality, projects like these sometimes get lost through the fold. We hope this cheat sheet is a great resource, but we also advocate readers go check out the report itself, especially if you’re looking for city by city case studies.
Why we didn’t: The presentation of the report online, while engaging and informative, makes it hard to share and summarize.
The Pandemic’s Lasting Impact on the Traditional Office
When Covid-19 hit the U.S., it triggered a mass exodus. Four years after the initial disruption, the office market continues to grapple with the aftermath. The current vacancy rate of 20.1% in the first half of 2024 is not just a number — it represents a fundamental reimagining of how and where work gets done. And the impact extends beyond just vacancy rates. Office utilization rates, which measure the share of in-office occupants compared to the total space available, have also seen a significant decline.
While recovery rates have improved with office utilization nearing 75% of its pre-pandemic figure for several U.S. metros, it’s unlikely to be enough to encourage a full recovery or growth in the sector.
A Tale of Two Office Market Classes
The impact of these changes has not been uniform across the office sector. A clear divide has emerged between prime, Class A properties and older, less desirable spaces:
Class A resilience: Newly constructed or recently renovated Class A properties are showing resilience in many markets. These buildings, often boasting state-of-the-art amenities and prime locations, continue to attract tenants seeking high-quality space for collaboration and client meetings.
For example, in Cleveland, the newly renovated AECOM Centre saw its vacancy rate drop from 45.2% in 2019 to 26.3% in 2024, bucking the broader market trend. Similarly, in Atlanta, the Bank of America Plaza reduced its vacancy rate from 45.4% to 30.3% over the same period.
These success stories highlight the importance of quality and amenities in the new office landscape. Buildings that can offer a compelling reason for employees to commute – whether through cutting-edge technology, superior design, or unbeatable locations – are better positioned to weather the current storm.
Struggling Class B and C properties: In contrast, older Class B and C buildings are facing significant challenges. Without capital for major renovations to make them competitive, many of these properties are confronting obsolescence. This has led to accelerating vacancy rates and declining values, making it difficult for investors and lenders to justify further investment.
The struggle of these older properties is particularly acute in cities with large inventories of aging office stock. In some cases, the cost of necessary upgrades may exceed the potential return on investment, leading owners to consider alternative uses for these buildings.
The Suburban Advantage
Interestingly, suburban office markets have shown more stability compared to their central business district counterparts. This trend is driven by several factors:
1. Shorter commutes: Employees are prioritizing convenience and work-life balance, favoring office locations closer to home.
2. Cost considerations: Both companies and employees are drawn to the often lower costs associated with suburban locations.
3. Quality of life: Some workers are opting for areas offering a better quality of life and lower cost of living while maintaining their remote jobs.
The Central New Jersey suburban office market exemplifies this trend. One Tower Center, the area’s tallest building, saw its vacancy rate plummet from 55.7% in 2019 to just 6.4% in 2024, significantly outperforming nearby urban centers.
This shift towards suburban offices is not just a short-term reaction to the pandemic. It reflects a broader reassessment of work-life balance and the role of the office in employees’ daily lives. Companies are increasingly adopting a “hub and spoke” model, maintaining a central headquarters while also offering satellite offices in suburban locations to provide employees with more choices and flexibility.
The Path Forward Requires Adaptation and Innovation
As the office sector navigates this period of upheaval, several strategies are emerging to address the challenges:
1. Adaptive reuse and conversions. One potential solution to rightsize the market involves converting outdated office buildings to other uses, such as residential or mixed-use developments. This approach can help reduce the overall office supply while addressing needs in other sectors of the real estate market.
However, the financial feasibility of conversions remains a significant hurdle. Not every office building is a suitable candidate for repurposing, and the costs associated with such projects can be prohibitive. Factors such as building layout, zoning restrictions, and market demand all play a role in determining whether a conversion project is viable.
Despite these challenges, successful conversions can breathe new life into struggling properties and contribute to more vibrant, mixed-use urban environments. Cities like New York and Chicago have seen a number of creative office-to-residential conversions that could serve as models for other markets.
2. Focus on quality and amenities. Developers and property owners are increasingly focusing on creating high-quality, amenity-rich spaces that offer a compelling reason for employees to come into the office. This includes features like state-of-the-art technology, wellness facilities, and collaborative spaces designed to foster creativity and teamwork.
The emphasis on amenities extends beyond just the physical office space. Many successful office properties are now part of larger ecosystems that include retail, dining, and entertainment options. These integrated environments aim to create a more holistic work experience that can’t be replicated at home.
3. Flexible leasing models are key. The traditionally long office lease of 10-15 years is becoming less common. Tenants are opting for shorter, more flexible lease terms that allow them to adapt to changing space needs. Property owners who can accommodate this desire for flexibility may find themselves at a competitive advantage.
This shift towards flexibility is also driving the growth of co-working and flexible office providers. While this sector faced challenges during the pandemic, it’s now seeing a resurgence as companies seek more agile real estate solutions.
4. Embrace the mixed-use developers. The future of office space may lie in integrated, mixed-use developments that combine work, living and leisure spaces. These “live-work-play” environments can create vibrant, 24-hour communities that are attractive to both employees and employers.
Mixed-use developments offer several advantages in the current market — and are a great opportunity for financial institutions looking for community-forward investments. They can help distribute risk across different property types, create built-in demand for office space from local residents, and offer the kind of vibrant, amenity-rich environments that many workers now expect.
Conclusion: A Sector in Transition
The record-high vacancy rates in the U.S. office market undoubtedly present significant challenges for commercial real estate lenders and investors. However, reports of the office sector’s demise are likely exaggerated. Instead, we are witnessing a period of correction and adaptation, requiring a recalibration of risk assessment models and lending strategies.
For bankers, this evolving landscape demands a nuanced approach to office property financing. The office sector of the future will likely be smaller, but also more dynamic and better attuned to the needs of a modern workforce. Success in lending will hinge on the ability to identify properties that offer clear value propositions — whether through prime locations, cutting-edge amenities, or the ability to foster collaboration and innovation. This may necessitate adjustments to underwriting criteria and a greater emphasis on the adaptability and future-proofing of office assets.
As the market continues to evolve, all stakeholders in the banking and real estate sectors will play a role in shaping the future of commercial property finance. This includes reassessing loan-to-value ratios for different classes of office properties, considering new metrics for building utilization in underwriting processes, and potentially exploring innovative financing structures for adaptive reuse projects.
The office is not dead, but it is being reborn, adapting to a new working order in a hybrid world. Financial institutions that can navigate this transition successfully — by accurately gauging risk, identifying emerging opportunities, and crafting flexible lending solutions — will be well-positioned to thrive in the post-pandemic commercial real estate landscape. This may involve closer partnerships with proptech firms, increased focus on ESG factors in building assessment and a more holistic view of mixed-use developments that include office components.
Editor’s note: This article was prepared with AI language software and edited for clarity and accuracy by The Financial Brand editorial team.