The U.S. Office Market: A Tale of Three Cities

A guest blog from Mark Fawer, a seasoned New York Real Estate attorney and Partner at Greenspoon Marder LLP.

“It was the best of times, it was the worst of times.” Dickens’ opening line in his great classic A Tale of Two Cities could well apply to the current state of the U.S. office market.

The “Worst of Times”: Rising Delinquencies and Vacancies

On one hand, the U.S. office market faces significant headwinds. Falling demand for office space, coupled with rising operating costs and interest rates, has led to a surge in delinquency rates for securitized office building loans. Last month, these rates spiked to 7%, a notable increase from 4% just a year prior. This is unsurprising, given that central business district office vacancies are currently at a staggering 19.2% nationwide.

The “Best of Times”: Trophy Assets Still Shine

On the other hand, the market isn’t entirely bleak. Trophy office assets in prime locations within top markets continue to command top dollar. For example, 590 Madison Avenue, the approximately 1 million square foot former IBM building in Manhattan, recently sold for close to $1.1 billion. Similarly, 1345 Avenue of the Americas, a 50-story, nearly 2 million square foot tower, was just refinanced for $850 million. These deals demonstrate that high-quality, well-located properties still hold significant value.

The Third Category: Conversions and Repurposing

Between the “dogs” (struggling properties) and the “darlings” (trophy assets), a third category is emerging: buildings ripe for conversion to a more viable, and often more lucrative, use—typically residential. According to a recent CBRE analysis, 23.3 million square feet of office space in the 58 largest U.S. markets are expected to be converted to other uses or demolished by the end of 2025.

Key Conversion Trends:

1. Multifamily: The most common repurposing, accounting for 76% of conversions.
2. Hotels: Following at 8%.

Notable Examples in NYC:

1. The former Pfizer headquarters at 219 and 225 East 42nd Street is undergoing a large-scale office-to-residential conversion, slated to yield over 1,600 apartments. This project recently secured a $720 million loan from Madison Realty Capital.
2. In Manhattan’s financial district, 25 Water Street has completed its conversion, now housing 1,320 apartments. This project was financed in 2022 by MSD Partners and Apollo.

Some of these conversion projects are further incentivized by New York’s 467-m Affordable Housing Tax Incentive Benefits program. This program provides a property tax abatement of 25, 30, or 35 years, depending on construction start, provided that at least 25% of the dwelling units qualify as “affordable.”

Why Aren’t More Conversions Happening?

Despite the clear benefits, not all distressed office buildings are suitable for conversion. Three primary reasons limit these opportunities:

1. Location: Mid-block properties often lack the necessary air and light for comfortable living spaces.
2. Physical Characteristics: Buildings that are too deep and wide are not conducive to residential layouts without expensive “coring” through the middle.
3. Zoning Restrictions: Existing zoning may not permit residential use or may overly restrict the number of units, making conversions financially unviable.

According to the Yardi Conversion Feasibility Index, only about 15% of the total 1.2 billion square feet of office buildings are considered viable conversion candidates.

Looking Ahead: Opportunities and Challenges

As time progresses, greater clarity will emerge regarding which category an office building falls into.

1. For Investors: This could present buying opportunities at lower prices, particularly for properties that have been unfairly stigmatized by a generalized negative perception of the office sector. The capital markets should provide competitive financing options for these acquisitions.
2. For Visionaries: The door opens for finding and converting “diamonds in the rough,” backed by lenders (especially subordinate capital providers) willing to assume greater risk for wider spreads.
3. For Laggards: Some buildings are destined for extreme price reductions, leading to impaired mortgage loans or even a more dire outcome: the wrecking ball. In such cases, the land value alone may exceed that of a building unable to cover its operating expenses and property taxes.

It is especially fitting to close with a quote from a Dickens character in Great Expectations: “I have been bent and broken, but – I hope – into a better shape.” Here’s to hoping that the same may be said of our office sector.

About the Author

Mark Fawer is a partner at Greenspoon Marder LLP in New York, New York. He specializes in representing institutional, fund, and private capital sources across all aspects of senior and subordinate real estate financing and equity investment. His expertise includes stretch senior, bridge, and mezzanine lending, B-notes, and preferred equity and joint venture investments, spanning a wide range of asset types. Mark is known for structuring cutting-edge financings and investments in challenging contexts, and he counsels clients from “term sheet to closing” in various other real estate transactions.

Specialties: Real Estate Acquisitions, Dispositions, Development and Joint Ventures, Real Estate Finance (including Construction and Bridge Lending, Mezzanine Lending, Preferred Equity and other Subordinate Financing), Commercial Loan Workouts and Restructurings, Intercreditor Disputes, Distressed Debt Investments.

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Contact for Leasing Inquiries

For any questions or requirements related to leasing office space in New York City, please feel free to contact:

Paul Walker Senior Vice President, CBRE Phone: 212-984-7117 Email: Paul.Walker@cbre.com LinkedIn: Paul Walker | LinkedIn [google.com]