By Peter Grant

America has a glut of office buildings. That longstanding surplus is finally shrinking.

The number of property demolitions and the pace of office conversions into residential buildings are accelerating. Developers, meanwhile, have greatly slowed new office construction because of questions about future tenant demand.

As a result, the amount of office supply in the U.S. is on pace this year to contract for the first time in a quarter of a century, according to real-estate-services firm CBRE Group.

If this trend holds, it would reverse a decadeslong office-construction spree that flooded the U.S. with too much unwanted workspace. Developers -- lured by federal tax breaks, low interest rates and inflated demand from unprofitable startups -- built more office towers than cities needed. The rise of remote work during the pandemic aggravated this excess supply, causing office-vacancy rates to rise to record highs and building values to plummet.

Conversions of office space into apartments held an obvious appeal. But the cost of acquiring an office building and addressing structural obstacles made these conversions too expensive to work in most cases.

Analysts had expected the office glut to take many years to shrink, not unlike the decade-plus it took for many U.S. cities to work off their excess of retail properties after e-commerce ascended.

Now, the pace of office conversions is picking up, thanks to the rapidly falling prices of obsolete office buildings, changes to zoning rules that allow for more residential construction, and government incentives that help bring down costs. At the same time, more companies are summoning their employees back to the office after years of tolerating remote work, sparking new demand for workspace.

The acceleration of office conversions won't sharply reduce the overall supply of office buildings any time soon. But conversions are already starting to benefit neighborhoods where they take place. By bringing in new residents, these projects are restoring street life, shopping and entertainment venues where obsolete office buildings used to stand.

"It is transformational," said Jessica Morin, the head of U.S. office research for CBRE Group.

In New York City, analysts are forecasting about 40 million square feet of offices to be converted into residential and other uses over the next five to 10 years. That is double the forecast two years ago, before tax benefits and other government incentives were enacted.

New York City developer Scott Rechler's current office-conversion project at Manhattan's 5 Times Square is a good example of one that benefited from the forces making this process more economically attractive today.

He and his partners are transforming a 1.1-million-square-foot office building into as many as 1,250 apartments, including 313 affordable units. The costs to acquire the property were about 40% less than the value of the building in 2019, in line with how much office values have fallen in New York over that period.

Rechler seized on new regulations allowing for more residential construction than was possible on the site in previous years.

The developer will also get a 90% tax abatement. Many conversions now in the pipeline "would not be economically viable without these programs in place," Rechler said.

With a growing number of developers taking advantage of these opportunities, the office market nationwide is on track to lose about 23.2 million square feet this year, CBRE said. That is more than three times the amount of office space removed in 2019.

Meanwhile, developers are expected to deliver only 12.7 million square feet of new space this year, pressured by high construction costs and mortgage rates. In 2019, developers delivered more than four times that amount of new office space.

Even with supply shrinking, it is too soon to call a full-blown office-market recovery. The vacancy rate nationwide is 19%, according to CBRE.

In many cities, vacancy rates and delinquent mortgages remain stubbornly high. And many landlords can't afford the cost of the upgrades and amenity packages that tenants are demanding.

"It's hard to be bullish on the sector as a whole," said Phil Mobley, CoStar's director of U.S. office analytics.

Still, conditions have improved since April, when concerns about tariffs and a possible recession persuaded many businesses to pause searches for new space. Leasing activity has resumed to the encouraging levels seen earlier this year.

Companies are also taking more space when they sign new leases. Currently, 40% of tenants in the market are in expansion mode, according to Liz Hart, Newmark's president of leasing for North America. In previous quarters, that was true for only 33% of the tenants looking for space, she said.

And some big investors that shunned office investments in recent years are jumping back in. Blackstone this month acquired a 46% stake in a Midtown Manhattan office building at 1345 Sixth Ave. in a deal that valued the 50-story tower at $1.4 billion. This and an earlier deal this year in San Francisco were Blackstone's first major U.S. office investments since 2022.

Blackstone decided to take the plunge in New York when it saw vacancy rates on Park Avenue and Sixth Avenue decline sharply because of steady demand and almost no new office development.

"Fewer options can lead to higher rents and higher occupancies," said Nadeem Meghji, Blackstone's global co-head of real estate.

Write to Peter Grant at peter.grant@wsj.com

(END) Dow Jones Newswires

June 17, 2025 05:30 ET (09:30 GMT)

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