According to real-estate investors, brokers, and analysts, America's office glut has been building for decades. Developers in the United States built far too many office towers, enticed by federal tax breaks, low interest rates, and inflated demand from unprofitable startups.
Simultaneously, landlords have largely failed to demolish or convert old, mostly vacant buildings to new uses.
As a result, the country has an excess of offices and an insufficient number of companies willing to pay for space in them. According to analysts, the rise of remote work during the pandemic exacerbated an already emerging problem.
The issue of office surplus is primarily an American one. According to brokerage JLL, approximately 19% of office space in the United States was vacant in the second quarter, compared to 14% in the Asia-Pacific region and 7% in Europe, the Middle East, and Africa. Analysts predict that share will rise as more leases expire and companies reduce their real estate investments.
High office vacancy rates jeopardize the financial stability of building owners and their lenders. They also harm the economies of cities like New York and San Francisco, which rely on cubicle farms to pay taxes and support local businesses.
Brokers and analysts attribute the U.S. office glut to a 1981 tax code change. To stimulate the economy, the Reagan administration, among other things, allowed investors to depreciate commercial real estate much faster than before, lowering their tax bills.
Brokers claim that savings and loan associations showered developers with easy loans. This contributed to the 1980s office-development boom, which drove up vacancies to record levels and contributed to the savings-and-loan crisis, in which many such institutions failed. Vacancy rates gradually fell in the 1990s, but rose again after the dot-com bubble burst and the subprime mortgage crisis.
Office demand began to decline in the decade following the 2008 subprime meltdown. To save money, more businesses are downsizing their office space. Companies realized they could save money by eliminating private offices and cramming more employees into open floor plans. Some companies have begun to allow remote work.
Despite this, the supply of office space continued to grow. Over the last two decades, substantial tax breaks and other subsidies have gone into projects like New York's Hudson Yards and the World Trade Center. Conversions of old, vacant office buildings into warehouses or apartments were uncommon.
Landlords became more adept at inflating rents in exchange for cash gifts and other incentives, creating the illusion of a strong market. Low interest rates and a flood of global capital into the US real-estate market boosted building values even as office demand fell, giving owners a false sense of security. According to David Lipson, president of real-estate brokerage Savills North America, these factors masked chronically high vacancies and prevented landlords from pursuing more conversions.
Co-working companies such as WeWork Inc., according to Sam Zell, chairman of Equity Group Investments, have also contributed to an oversupply of office space. In the years preceding the pandemic, such companies leased far more space than they could fill with customers, covering their losses with billions of dollars from venture investors.
"By obscuring those numbers, we encouraged developers to come in and add office space in markets where there was no demand," Mr. Zell explained earlier this year at New York University's annual REIT Symposium. LaSalle Street in Chicago, which is densely packed with office towers, is now "a nowhere land with a whole bunch of obsolete buildings," he adds.
The highest vacancy rates are found in older buildings, which lack modern amenities and are less environmentally friendly. When it first opened in 1989, 100 East Wisconsin Avenue in Milwaukee was the second-tallest building in the state. The 35-story tower, located two blocks from a freeway exit ramp and equipped with a 750-car garage, was ideal for office workers commuting from outlying suburbs.
However, in the years preceding the pandemic, developers constructed a number of glassy new office towers nearby, luring away 100 of East Wisconsin's largest tenants. According to CoStar Group data and a person familiar with the situation, more than half of the building is currently vacant, and the two largest remaining leases are set to expire next year. In early 2021, the property was turned over to a receiver after the owner, Hertz Investment Group, was unable to pay the mortgage.
According to Jared Friedman, senior managing director at the building's manager, Friedman Real Estate, a number of investors have expressed interest in purchasing 100 East Wisconsin and converting it into apartments. According to him, the building's relatively small floors make it a good candidate for conversion.
However, brokers say that many other aging office buildings lack such features. Conversions are also made more difficult by rising construction costs and high interest rates. "It won't be the savior of all that obsolete office space," Julie Whelan, global head of occupier research at brokerage CBRE, said.
Instead, many old office buildings will almost certainly be demolished. Brokers predict that the process will be lengthy because property owners frequently refuse to accept that their investment has been lost. A decrease in new office construction could help the market recover, but it will take years to take effect.
Meanwhile, vacancy rates are expected to rise further. Some analysts predict that remote work will reduce demand for office space by up to 20% in the coming years, though some brokerage firms predict a smaller drop. More buildings will most likely go into foreclosure.
"Time solves all problems," Mr. Zell said. "The pain between here and there can be severe."