BXP boss says office sector is overvalued

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The US office market has been in chaos since the beginning of the pandemic, when employees were first asked to go home. Some, especially younger workers, never returned — leaving many office buildings half-full or empty.

However, the overall office vacancy rate fell 20 basis points in the third quarter to 18.8%, according to CBRE. Although this is still historically high, it represents the first year-over-year decline in job openings since the first quarter of 2020, when the coronavirus took hold in the United States.

Leasing activity in the latest quarter exceeded the five-year quarterly average, driven by financial services and technology companies, according to the report. The construction pipeline also declined and is on track for its lowest annual total in more than a decade.

“I definitely think we’ve hit bottom. I think we’ll hit bottom in 2024,” said Owen Thomas, CEO of BXP (formerly Boston Properties), the largest office REIT in the United States. “There are a lot of positive things happening for some of the office business, not all of it.”

One of those positives is low interest rates. Capital is coming back into office properties, starting on the debt side, where there have been several large debt securitizations, Thomas said. BXP has just completed single-asset securitizations in high-end office buildings in New York City and Boston, he said.

BXP invests almost entirely in the upper tier of the market, with many of its tenants working in financial and legal services. That’s another positive, Thomas said. Financial services companies are seeing significant profit growth, partly due to artificial intelligence. These companies also tend to use their space more than others.

“These leading companies want to get their employees back to their offices, and of course, they can enforce that, but what they really want is they want their employees to want to get back to their offices,” Thomas said. “That’s why you see this bifurcation in the office business, between the high-quality buildings that are being leased by leading companies and then the rest, which is not performing nearly as well as what we call, the industry-leading workplace sector.”

This “premium” level is roughly defined as the top 10% of buildings. The vacancy rate in these buildings is much lower than the rest of the market — 11% on average in the cities where BXP operates, Thomas said, adding that asking rents in those markets are 55% higher.

However, featured buildings are not always new buildings. They are also buildings located in desirable locations, especially with easy access to mass transportation. There has also been a new campaign from owners of Grade II buildings to compete with so-called Class A properties.

“There are a lot of office owners today who have a strategy, ‘We’re not trying to be the first provider of workplaces, we’re trying to be the best provider of second-tier buildings,'” Thomas said. “They’re fixing up their buildings. They’re offering some of these amenities, and they’re offering a more value-oriented price point. So I think a lot of the demand will go to that.”

BXP, for its part, is not particularly interested in acquiring these buildings, he added. Instead, it is putting venture capital into new development, recently launching a $2 billion project at 343 Madison Avenue in New York City. Even with long construction timelines, Thomas said the resulting return is much better than existing buildings, even at their lower prices.

As for the impact of Mayor-elect Zahran Mamdani on the city’s real estate, Thomas seems cautiously optimistic.

“Our success in any community hinges on the success of our community, so if the city isn’t successful, we can’t be either. We want to do what we can to help him figure out some of the things he promised as a candidate,” Thomas said, specifically referring to housing affordability and public safety.

“I’m not sitting here saying I think it’s going to necessarily be positive, but I think, given the consent rights that the state has over many things, and some of the early decisions I see him making, like rehiring the police chief, I think some of those decisions make us feel constructive about what that outcome might look like,” Thomas said.

He pointed to New York City’s progress in converting offices to residential as a model for other cities, saying that because rents are so high, the deals work out financially. New York has also put in place tax incentives for developers, which Thomas described as encouraging.

As for the rest of the country, transfers will not solve the problem of vacant offices, Thomas said.

“The office market in general is overbuilt. There will be buildings that will be torn down and converted into something else. We’re doing some of that in suburban sites,” Thomas said. “But the shift is, when people approach this topic, they think this is going to be the answer.

“That would be an answer. It’s not the answer,” he said.