Real Estate

Office Trends in 2024 – Commercial Property Executive

Companies such as JLL are addressing the crucial need for collaboration, innovation and employee well-being. Pictured here, JLL’s office in Phoenix. Image courtesy of JLL

At the beginning of 2024, the office sector finds itself at a pivotal juncture, navigating a landscape shaped by a confluence of transformative forces. The repercussions of the pandemic continue to reverberate, prompting a profound reevaluation of traditional office paradigms.

Remote work has entrenched itself as a lasting feature, overhauling they way organizations conceptualize and utilize office spaces. Hybrid work models have become the norm, fostering a newfound flexibility that challenges age-old conventions such as the 9-to-5 workday. Against this backdrop, companies are grappling with the imperative of fostering collaboration, innovation and employee well-being, which is sparking a metamorphosis in office design and functionality.

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“The office sector forged its way forward in 2023 as the world adapted to a new normal,” Elizabeth Hart, president of leasing for North America at Newmark, told Commercial Property Executive. “Significant demand for trophy space which enhances the tenant experience persisted, and many business leaders confirmed that in-person collaboration was a critical foundation to their company’s success.”

This prompted a two-way engagement between landlords and tenants, emphasizing collaborative and informed approaches. Demand for a data-driven real estate advisory approach intensified, with top talent leveraging data methodologies to exceed client expectations.

How 2023 set the scene for future shifts

Delving into the specific trends that shaped the office sector in 2023, Doug Ressler, manager of business intelligence at Yardi, underscored the prevalence of “quiet hiring” and the emergence of new hybrid work models. Illustrating the industry’s adaptability to evolving employment dynamics, there was a rising interest in coworking spaces and flexible lease contracts, which conveyed a departure from traditional office setups and an alignment with the broader trend of tailoring office spaces to dynamic business needs.

Amid these shifts, uncertainty in the commercial real estate market for owners and users alike prevailed, according to Jim Kruse, regional president of brokerage for Greater Los Angeles at Kidder Mathews.

“The U.S. commercial real estate market has certainly been in down times previously, but nothing like the current murkiness of not knowing what the end result is going to look like with the attitudes of the tenants about returning to work,” Kruse said. “Employers are reluctant to mandate a return, and employees do not know what the job market looks like if they were to refuse a mandate to return to work.”

The office sector experienced an excess of 58 million vacant square feet compared to occupied space through July, resulting in a record-high national office vacancy rate of 18 percent, according to CommercialEdge data. This surge was influenced by a slightly above-average introduction of new office space to the market, advancements in remote technology and the integration of flexible workspaces. The growing number of offices under construction and ongoing technological progress indicate forthcoming challenges for the office sector as it adapts to evolving work patterns and needs.

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“Physical office occupancy remains stubbornly low,” said Peter Kolaczynski, director at CommercialEdge. “A glass half-full perspective would be that the current physical occupancy is worst-case scenario prediction from 2020 and the outcome thus far has not been worst-case scenario, which reinforces how this problem is long term, given the length of leases going into 2020.”

Once again highlighting the need for adaptability in today’s dynamic business landscape, Ressler suggests that flexible seating arrangements were at the core of the evolving workplace last year. Such arrangements, incorporating aspects of technology, hybrid operations and the flex model, showcased the industry’s response to the changing needs of contemporary office users. The interplay of these factors defined the narrative of the office sector in 2023, setting the stage for continued evolution and adaptation in the years to come.

What’s in store for the office sector in 2024?

office sector hybrid work

Max Tech Center in Boulder County, Colo., showcases modern communal areas and high-tech amenities throughout an expansive facility. Rendering courtesy of Alvarez & Marsal

Building upon the transformative landscape set in 2023, the office sector is poised for notable changes and challenges in the year that just started. Hart anticipates a surge in demand driven by employment growth across various office-using industries. Her positive outlook is underpinned by an impressive 11.5 percent increase in new business formation since September 2022, signaling a robust economic backdrop.

The stabilization of employer/employee expectations regarding in-office work further contributes to this optimistic forecast, as businesses proactively address economic uncertainties and incorporate advancements in AI-driven technology.

However, several headwinds will persist for the office sector in the new year.

“The market is still in the process of adapting to hybrid work as the dominant working pattern, as only 28 percent of pre-pandemic leases of large blocks of space have come up for renewal,” said David Bitner, executive managing director of global research at Newmark.

Bitner noted there’s an abundance of low-quality office spaces nationwide, with 16 percent of them having a lease rate of 70 percent or less. Kolaczynski acknowledges the challenge of functionally obsolete office space dragging down the market, emphasizing that localized approaches are crucial for resolution. Flexibility will be a key trend in 2024, with varying requirements leading to smaller fixed spaces but increased flexible options.

“Quality locations and quality product will continue to see interest and be the driving factor,” he noted. “Much like in retail through the past 20 years, there were clear winners and that concept will bleed into office.”

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Ressler believes most businesses will reduce their office square footage in 2024, mandating specific onsite workdays. But despite the rise in in-person attendance, there is an expectation of office downsizing as companies seek financially viable space levels. This will push owners to continue to adapt layouts and amenities to suit evolving work behaviors, including soft seating, collaboration rooms, wellness spaces and hot desking. Office space users are demanding more stimulating and responsive work environments, so landlords are anticipated to invest in amenities and technologies to differentiate offerings and create dynamic communities.

But beyond all these concerns, the top challenge for landlords this year will be handling potential delinquencies and loan defaults. The office sector faces significant distress, with a substantial portion of loans maturing by 2025, posing challenges for refinancing.

“Office owners with loans maturing in the next three years—totaling more than 9,500 buildings and 17 percent of office stock—face an uphill battle,” Ressler warns.

The maturing debt challenge

Kolaczynski agrees that access to capital and the high cost of capital will remain an issue for the office sector. Though expressing concern about maturing debt, he acknowledges the deviation from the predicted doom and gloom.

“While we have not seen a wave of foreclosures, cost of capital is a continued issue for the foreseeable future,” Kolaczynski said.

Meanwhile, Ressler underscores the substantial funding gap confronting the office sector due to lower loan-to-value ratios and substantial value erosion.

“Between 2023 and 2025, office owners will face a financing gap of $72.7 billion—or 26.4 percent of the lending volume originated between 2018 and 2020,” he said. “This will likely lead to distress for some property investors and force others to inject more cash into their properties. The retail sector faces a similar problem, but at a much smaller magnitude.”

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The cumulative funding gap could cause distress for investors unwilling or unable to invest more cash, resulting in losses for lenders due to falling property values and illiquid markets. Notably, high-profile defaults have already occurred in the early part of 2023. According to Hart, $190 billion in office loans matured in 2023, marking the largest maturity year tracked by Newmark Research. And with expectations of significant annual maturities in 2024 and 2025, proactive measures are needed to navigate this period diligently and collaboratively, but this is no easy feat.

Ressler suggests that pessimistic lenders may bundle non-performing loans for sale on the secondary market at a discount. Lenders with conviction may opt for loan workouts and short-term accommodations. While the funding gap presents opportunities for equity investors and mezzanine lenders, the availability of mezzanine debt is uncertain. European insights indicate a decrease in subordinated debt origination as debt investors adopt a cautious approach.

All in all, Kruse believes significant changes will unfold by the end of 2024, barring unforeseen political or international events. The impending challenge of maturing debt is pivotal, and the industry’s response to bridge this gap will offer crucial insights into large investors’ expectations for the sector in the coming years.

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