Home Insights Real estate U.S. Real Estate Office: Is the worst behind us?
page assignment hero

U.S. Real Estate Office: Is the worst behind us?

April 16, 2025 | 5 min read
Art Jones
Senior Director, Global Real Estate Research and Strategy
Madhan Rengarajan, CFA
Senior Director, Capital Markets Research
Christian Floro, CFA, CMT
Market Strategist

The U.S. office sector has been the hardest hit during the recent corrective period for commercial real estate. 10-year Treasury yields that are about 170bps higher than where they were in the post-GFC period have created headwinds for real estate assets in general. Office assets, meanwhile, have also underperformed due to a lack of physical demand related to the aftereffects of the pandemic. While it appears we’re at the beginning of a recovery for office valuations, as the sector’s operating fundamentals show promise, it still faces significant challenges before it can return to prominence in institutional portfolios.

Dislocations created by the pandemic

Historically, the office sector was linked to broader economic growth, with demand closely aligned with hiring within the professional services sector. The pandemic upended this relationship as the rise of working arrangements, including work-from-home and hybrid agreements, have created a dislocation between traditional demand drivers and net office demand. This has been evident as the historical correlation between office employment and net leasing activity, also known as the absorption rate, dropped significantly between the period before and after the pandemic.

These idiosyncratic challenges have consequently required a more nuanced view of the office sector, especially compared to other real estate sectors. For the latter, the price correction has been largely a function of higher interest rate related capital market disruptions, despite fundamentals like leasing activity holding steady. The office sector, meanwhile, has not only faced the same interest rate related pain but also must contend with the shift in post-pandemic demand dynamics weighing on fundamentals. Indeed, within the office sector, the most acutely impacted by reduced in-office attendance segments have been older vintage assets, which tend toward functional obsolescence and may need to be repurposed.

A bottom may be in sight…

The good news for the office sector is that demand and occupancy have begun to stabilize, as CEOs have doubled down on efforts to improve in-office attendance. The national vacancy rate remains near its peak of 19% but has not increased since the first half of 2024. While much work must be done before the market reaches equilibrium, the sector appears on the cusp of recovery. Much of the stability in the sector is due to the strong performance of newer and higher-quality assets, which have maintained a commendable demand profile throughout the correction. Class A offices delivered after 2010, for example, have a vacancy rate of just 15% and have sustained positive net leasing activity.

…but challenges remain

While the sector is entering a period of stability and recovery, it remains well behind other real estate sectors on several fronts. Distress within the office sector remains evident due to the ongoing decline in valuations and upcoming loan maturities that total nearly $300 billion over the next two years, according to the Mortgage Bankers Association. Office values have declined by 38% since 2020, marking the largest fall since the Savings and Loan Crisis of the 1980s. Allocations to the sector remain challenged as well, with many large institutional investors likely to continue reducing their positioning further. Indeed, today, office accounts for just 18% of the NCREIF Open Ended Core Diversified Equity Fund (ODCE) Index, well below its pre-pandemic peak.

Ongoing pessimism in the space is partially a function of the uncertainty surrounding office’s future demand profile, coupled with high operating expenses. This has negatively impacted lease profitability as effective rents have continued to experience declines due to increases in tenant compensation, such as tenant improvement allowances and extended periods of free rent. In many cases, it may take an office owner 40% to 60% of the lease term to just recover the capital outlay required to initiate a lease, which typically translates into weak lease profitability and asset ROI.

Investor considerations

These challenges are likely to continue creating a moderate headwind for investors and will make the opportunity set more bifurcated and limited. But as the office market gradually stabilizes and transitions into recovery, there will be opportunities for investors with the right type of capital to take advantage of pricing dislocations. Indeed, office is an environment benefiting from an active approach as higher quality assets in stronger markets should perform much better than general market or index aggregates.

Core opportunities will remain governed by corporate uncertainty around occupancy plans but continue offering investors attractive yields on stable properties. Moreover, ongoing distress and a lack of debt capital supplying the sector is likely to provide attractive lending opportunities with higher relative yields for lenders willing to move further out on the risk curve. Ongoing pricing dislocations within core plus, value-added debt, and opportunistic equity could offer attractive long-term entry points. Finally, higher-risk capital that can take leasing and exit risks can find value in equity opportunities heavily discounted to reproduction costs in select markets.

Apart from operational challenges, the office sector will likely remain highly exposed to economic risk. Both geopolitical and policy risks remain elevated and may potentially disrupt the current expansion and demand recovery, which would provide a setback for commercial real estate and the office sector.

The U.S office sector: challenges are opportunities

Along with higher interest rates, exacerbating the U.S. office sector’s woes has been the lack of physical demand related to the lingering impact of the pandemic, primarily from the rise of work-from-home and hybrid arrangements. Yet, there are signs that occupancy has begun to stabilize, suggesting a bottom in office valuations may finally be in sight. However, the sector still faces significant challenges, including elevated distress, uncertainty over future demand, and high operating expenses. Nevertheless, this should open the door to a more bifurcated opportunity set than prior recoveries, benefiting from an active approach for the right capital and risk budget.

Real estate
Disclosure

For Public Distribution in the U.S. For Institutional, Professional, Qualified and/or Wholesale Investor Use Only in other Permitted Jurisdictions as defined by local laws and regulations.

Risk considerations
Investing involves risk, including possible loss of Principal. Past Performance does not guarantee future return. All financial investments involve an element of risk. Therefore, the value of the investment and the income from it will vary and the initial investment amount cannot be guaranteed. Potential investors should be aware of the risks inherent to owning and investing in real estate, including value fluctuations, capital market pricing volatility, liquidity risks, leverage, credit risk, occupancy risk and legal risk. All these risks can lead to a decline in the value of the real estate, a decline in the income produced by the real estate and declines in the value or total loss in value of securities derived from investments in real estate.

Important information
This material covers general information only and does not take account of any investor’s investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. Information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, nor an indication that the investment manager or its affiliates has recommended a specific security for any client account. Subject to any contrary provisions of applicable law, the investment manager and its affiliates, and their officers, directors, employees, agents, disclaim any express or implied warranty of reliability or accuracy and any responsibility arising in any way (including by reason of negligence) for errors or omissions in the information or data provided.

This material may contain ‘forward‐looking’ information that is not purely historical in nature and may include, among other things, projections, and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

This material is not intended for distribution to or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

This document is intended for use in:

  • The United States by Principal Global Investors, LLC, which is regulated by the U.S. Securities and Exchange Commission.
  • Europe by Principal Global Investors (Ireland) Limited, 70 Sir John Rogerson’s Quay, Dublin 2, D02 R296, Ireland. Principal Global Investors (Ireland) Limited is regulated by the Central Bank of Ireland. Clients that do not directly contract with Principal Global Investors (Europe) Limited (“PGIE”) or Principal Global Investors (Ireland) Limited (“PGII”) will not benefit from the protections offered by the rules and regulations of the Financial Conduct Authority or the Central Bank of Ireland, including those enacted under MiFID II. Further, where clients do contract with PGIE or PGII, PGIE or PGII may delegate management authority to affiliates that are not authorized and regulated within Europe and in any such case, the client may not benefit from all protections offered by the rules and regulations of the Financial Conduct Authority, or the Central Bank of Ireland. In Europe, this document is directed exclusively at Professional Clients and Eligible Counterparties and should not be relied upon by Retail Clients (all as defined by the MiFID).
  • United Kingdom by Principal Global Investors (Europe) Limited, Level 1, 1 Wood Street, London, EC2V 7 JB, registered in England, No. 03819986, which is authorized and regulated by the Financial Conduct Authority (“FCA”).
  • This document is marketing material and is issued in Switzerland by Principal Global Investors (Switzerland) GmbH.
  • United Arab Emirates by Principal Investor Management (DIFC) Limited, an entity registered in the Dubai International Financial Centre and authorized by the Dubai Financial Services Authority as an Authorised Firm, in its capacity as distributor / promoter of the products and services of Principal Asset Management. This document is delivered on an individual basis to the recipient and should not be passed on or otherwise distributed by the recipient to any other person or organisation.
  • Singapore by Principal Global Investors (Singapore) Limited (ACRA Reg. No.199603735H), which is regulated by the Monetary Authority of Singapore and is directed exclusively at institutional investors as defined by the Securities and Futures Act 2001. This advertisement or publication has not been reviewed by the Monetary Authority of Singapore.
  • Australia by Principal Global Investors (Australia) Limited (ABN 45 102 488 068, AFS Licence No. 225385), which is regulated by the Australian Securities and Investments Commission and is only directed at wholesale clients as defined under Corporations Act 2001.
  • Hong Kong SAR (China) by Principal Asset Management Company (Asia) Limited, which is regulated by the Securities and Futures Commission. This document has not been reviewed by the Securities and Futures Commission.
  • Other APAC Countries/Jurisdictions. This material is issued for Institutional Investors only (or professional/sophisticated/qualified investors, as such term may apply in local jurisdictions) and is delivered on an individual basis to the recipient and should not be passed on, used by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation.

Principal Global Investors, LLC (PGI) is registered with the U.S. Commodity Futures Trading Commission (CFTC) as a commodity trading advisor (CTA), a commodity pool operator (CPO) and is a member of the National Futures Association (NFA). PGI advises qualified eligible persons (QEPs) under CFTC Regulation 4.7.

Principal Asset Management℠ is a trade name of Principal Global Investors, LLC.

Insurance products and plan administrative services provided through Principal Life Insurance Co. Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc. Securities are offered through Principal Securities, Inc., 800‐547‐7754, Member SIPC and/or independent broker/dealers. Principal Life, Principal Funds Distributor, Inc., and Principal Securities are members of the Principal Financial Group®, Des Moines, IA 50392.

© 2025 Principal Financial Services, Inc. Principal®, Principal Financial Group®, Principal Asset Management, and Principal and the logomark design are registered trademarks and service marks of Principal Financial Services, Inc., a Principal Financial Group company, in various countries around the world and may be used only with the permission of Principal Financial Services, Inc. Principal Real Estate is a trade name of Principal Real Estate Investors, LLC, an affiliate of Principal Global Investors.

4414109
About the author