American Realty Advisors Sees Cautious Optimism in Office Real Estate Market Amid Supply Constraints

American Realty Advisors executives expressed cautious optimism about the office real estate market in a recent market commentary, pointing to improving conditions for top-tier properties even as the sector continues to face significant headwinds.

Sabrina Unger, American Realty Advisors' Head of Research and Strategy, noted that prime Class A-plus buildings are seeing solid demand patterns that are beginning to translate into asking rent growth. She attributed the improving outlook to a combination of sustained demand for best-in-class buildings and a supply pipeline that is "effectively shutting off."

Financing Constraints Impact Office Development

"It's very difficult to get financing for new office and with overall vacancies at the level they are, it's much harder to justify new development," Unger said in the conversation with Jay Butterfield. "So we have a combination of factors where demand for the best-in-class buildings is solid, asking rent growth seems to be turning a corner, and we are anticipating much less new supply to compete with."

Unger characterized the current environment as "generally better than what we might have seen two or three years ago," though she cautioned that the sector still faces challenges and is not expected to reach long-term average vacancies or rent growth anytime soon in the aggregate.

Tenant Improvement Costs Create Challenges for Core Office Investors

Butterfield discussed the challenges preventing more core capital from operating in the office space, highlighting the amount of capital required for tenant improvements as a significant obstacle. "One of them is the amount of capital you have to put aside for tenant improvements," Butterfield said. "Tenants are asking owners for more tenant improvements to make the space like they want it to be, and usually higher tenant improvement costs, you can translate those into longer-term leases, but today it's different."

He noted that landlords could spend $100 per square foot or more in tenant improvements without securing longer lease terms, particularly in markets with substantial excess supply where tenants have numerous options.

Office Real Estate Performance Versus Diversified Benchmarks

Unger raised questions about the ability of core or core-plus diversified funds to outperform benchmarks like ODCE, which are heavily weighted toward sectors like industrial and residential, by making investments in office. The discussion centered on whether office investments can deliver appropriate risk-adjusted returns in the current environment.

The commentary from American Realty Advisors comes as the office sector continues to navigate elevated vacancy rates across many markets. While the firm sees emerging opportunities in select Class A properties, the broader office market faces ongoing adjustments as development activity slows due to financing constraints and elevated vacancies.