The Crystal Ball: A Look at Office in 2024

The office sector has been hammered in 2023 as owners and tenants continue defining what the “new normal” looks like in the wake of the pandemic shutdown. To determine what 2024 might bring, Connect CRE asked experts who lent their insights to the recent “beyond the negative office headlines” series to unpack their crystal balls.

Each expert had their thoughts, but the common denominator was continued hybrid work arrangements, ongoing flight to quality and uncertainty over capital availability.

Hybrid Work: Here to Stay

The experts all agreed: Hybrid work isn’t going anywhere anytime soon.

Petra Durnin with Raise Commercial Real Estate said that the hybrid workspace is the next level of office space usage. “The hybrid workplace is becoming a permanent fixture synonymous with work styles that maximize efficiency and nurture creativity and innovation,” she commented.

Because of this, “tenants can use space more efficiently,” according to Stream Realty Partners’ Adam Showalter. “In addition to seeking high-quality space to attract and retain talent, occupiers can occupy Tier 1 office assets at comparable or lesser occupancy costs than in Tier 2 and 3 in prior years.”

As such, this doesn’t mean workers will be at home 100% of the time. The experts also agreed that return-to-office would continue well into next year.

“The return-to-the-office trend will continue in 2024 as companies determine what a flexible schedule looks like for employees and what matters most regarding office space,” said Aarica Mims with KDC.

Lee & Associates’ Tony Russo agreed, noting that there will be a resurgence in return-to-office. “Tenants are now more certain about how they will utilize office space in a post-pandemic world. The hybrid work model is expected to firmly establish itself in the form of smaller, more flexible layouts that support collaboration, creativity, innovation and team synergy,” he observed.

This, in turn, will support what’s currently going on – the flight to quality office space. Said Mims: “The demand for Class A buildings that are fully amenitized, provide collaborative environments, and offer the best in technology – will be sought-after spaces.”

Flight to Quality to Continue

The demand for fully amenitized buildings means that 2023’s flight-to-quality trend will be a factor in 2024. This is the case “as businesses and tenants prioritize high-quality, amenity-rich spaces that enhance the overall work experience,” Russo said.

David Martin with Terra said that the most attractive buildings to occupiers and their employees will be more than brand new. “Health and wellness-focused amenities, sustainability and energy-efficient building infrastructure and hospitality-driven services will continue to be key drivers as companies seek new office space,” Martin observed.

Owners and landlords, keeping this in mind, should do well in 2024. This trend will mean good news for owners of higher-tier office buildings. “Tier 1 assets are 88% – 92% occupied across all major office markets,” Showalter commented. “They will continue to garner outsized demand and record rental rates for 2024.”

Scott Morse with Citadel Partners agreed that Class AA buildings will perform well and garner a large chunk of tenant activity in 2024. But the Class A- and Class B+ buildings, “the ones I lovingly refer to as the ‘so what buildings,’ will continue to struggle when it comes to gaining interest from prospective or existing tenants,” Morse commented.

But don’t count out the older buildings, Durnin said. “As Class A space availabilities tighten, companies will seek alternatives to create versatile, adaptable environments for their employees,” she said, adding that Class B and C spaces could benefit from this trend.

The flight to quality could also mean scarce supply within the higher-class space. “We’re already seeing an increase in space demand while supply stays in check, given new development and product brought offline,” observed Eli Randel with CREXi.

Capital as a Question Mark

Morse’s viewpoint on debt and equity for office was somewhat grim, especially for the older, lower-class buildings. “The market will see sponsors and investors struggle to put more equity into those ‘so-what’ buildings to meet the tenants’ needs and desires,” he said. “And I think you’ll see sponsors struggle to put more money into equity payments to refinance their loans, as they wonder if their assets will attract new tenants with additional capital infusion.”

He added that there will likely be increasing foreclosures or deeds in lieu for poorer-performing buildings. But there was some optimism in his comments as well. The less-desirable buildings could provide ideal opportunities for those waiting on the sidelines.

“In comparison to the investor who paid a premium five to seven years ago because of low-interest rates, the new investor will be at a much better basis and will be able to invest the necessary capital, even at a higher interest rate, to gain traction with the tenant community,” he pointed out.

Furthermore, the wave of office maturities, resulting in workarounds or trades, could “reset the cost basis and allow landlords to offer more flexible and compelling lease terms,” Randel noted.

Showalter and Russo were also optimistic, with Russo indicating that seller-financed options would have an advantage “since our current environment favors financial flexibility.” He commented that some lenders taking over Chicago-area properties have offered buyers opportunities to assume or provide new loans. “We see this trend continuing as a creative way to offset higher interest rates and financing challenges that are hand-in-hand with the office sector,” Russo said.

Furthermore, Showalter said capital from additional sources could fill the gap. “I expect private capital and high-net-worth to enter the market in 2024 for Tier 1 office assets,” he said. “This will happen across all major markets, regardless of the debt markets thawing in 2024 or 2025.”

Not Great, but Not Horrible

The upshot from the experts is that the sector will remain bifurcated and that occupiers are learning new ways to use office space successfully as part of a hybrid work arrangement. Office conversions to other uses will also be on the board, with “office-to-family conversion continuing to dominate the conversation despite the relatively high level of difficulty and cost to complete these projects,” Russo said.

In short, office could be climbing out of “doom-and-gloom” territory in 2024, depending on how upcoming maturities are handled and assuming continued return-to-work policies. Noted Randel: “We don’t envision full recovery in 2024, but upward momentum and reversion back toward the mean.”