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REITs underperform as office space demand shifts

REITs underperform as office space demand shifts

06/23/2025
Robert Ruan
REITs underperform as office space demand shifts

The global landscape of real estate investment trusts (REITs) is undergoing a profound transformation driven by shifting workplace dynamics and evolving investor priorities. As demand for office space adjusts to hybrid and remote work models, traditional office-focused REITs are facing significant headwinds. Meanwhile, other sectors are stepping into the limelight, showcasing resilience and growth potential for those willing to adapt.

While the FTSE Nareit All Equity REIT Index delivered a 14% total return through November 2024, the drag from office assets has tempered broader performance. Understanding these trends is essential for investors seeking to align their portfolios with emerging opportunities across the REIT spectrum.

The Performance Landscape

REITs demonstrated remarkable resilience in 2024, outpacing private real estate by approximately 17 percentage points. This relative strength was propelled by sectors such as industrial logistics, data centers, and cell towers. Yet office REITs lagged behind, underscoring a fundamental shift in commercial real estate demand.

Looking ahead to 2025, analysts forecast average total returns of 9–9.5%, with a wide range spanning from 0% to 15%. Earnings growth (FFO/AFFO) is expected to average around 4.8%, reflecting steady growth tempered by caution over interest rates and macroeconomic uncertainty. With central banks poised to ease monetary policy, investors anticipate a modulating interest rate environment that could bolster overall REIT performance.

Office REITs: Drag on Returns

Office properties represent approximately 6% of global REIT market capitalization, yet they have become the primary source of underperformance. Persistent vacancy rates, sluggish job growth in office-centric sectors, and elevated sublease availability have weighed heavily on fundamentals. As of late 2024, there were 175 million square feet of discounted sublease space on the market, placing downward pressure on rents, especially within Class B and C properties.

Landlords of lower-tier buildings have been forced to offer significant concessions to retain tenants, eroding net operating income and compressing valuations. This trend highlights the divergence between prime office assets, which command premium rents, and secondary markets struggling to adapt.

A Tale of Two Office Markets

Within the office sector, a clear bifurcation is emerging. hybrid and remote work models have accelerated demand for high-quality, amenity-rich properties in prime locations. These Class A buildings are expected to see vacancy rates return to around 8.2% by 2027, as scarcity and tenant preferences drive rental growth.

Midtown Manhattan exemplifies the resilience of top-tier submarkets, showcasing rising leasing activity and declining vacancy. Office REITs with exposure to such markets stand to benefit from acquisition opportunities at distressed valuations as private owners face higher capital costs and limited liquidity.

Conversely, Class B and C offices face structural challenges. Tenants in cost-sensitive industries like government, healthcare, and education are driving demand here, but the volume of available space far exceeds current leasing activity. Rent reductions and tenant incentives remain the norm rather than the exception.

Shifting Strategies and Acquisition Opportunities

Faced with these headwinds, REIT managers are recalibrating their strategies:

  • Targeting high-quality assets at attractive discounts to capitalize on market dislocations.
  • Prioritizing upgrades and amenity enhancements to attract hybrid workforce tenants.
  • Leveraging balance sheet strength to outbid private landlords for prime properties.
  • Divesting non-core office holdings to redeploy capital into growth sectors.

By focusing on properties with strong tenant covenants and long-term lease profiles, office REITs can position themselves for a recovery once leasing volume grows. Industry forecasts project a 5% increase in leasing activity for 2025, signaling an end to the contraction phase.

Diverse Sectors Fueling Resilience

While office underperformance garners headlines, other REIT sectors are charting robust growth trajectories. Industrial and logistics properties benefit from sustained e-commerce expansion, while data centers and cell towers thrive on relentless demand for digital infrastructure. Rental residential REITs are supported by tight housing markets and rising demand for multifamily and single-family rentals.

  • Industrial/logistics: Strong leasing activity near ports and distribution hubs.
  • Data centers: Expanding capacity to support AI, cloud computing, and edge infrastructure.
  • Residential: Supply constraints in major metros driving rent growth.
  • Healthcare: Aging demographics boosting demand for medical offices and senior housing.

This diversification has helped the overall REIT index maintain stability, with secular demand drivers offsetting sector-specific headwinds. Investors with exposure to structural growth sectors with high demand have seen more consistent returns than those concentrated in office real estate.

Navigating Risks in Uncertain Times

Despite optimistic forecasts, several risks loom on the horizon. Persistent high vacancy in lower-quality offices could prolong rent declines, and policy changes—such as increases in property transfer taxes or local regulations—may impact valuations. Additionally, macroeconomic shocks or shifts in interest rate policy could affect capital markets sentiment.

Investors should consider the following risk management tactics:

  • Maintaining portfolio diversity across sectors and geographies.
  • Monitoring labor market trends to gauge hiring in office-centric industries.
  • Assessing balance sheet health, including leverage and interest coverage ratios.
  • Staying abreast of regulatory developments and local market conditions.

Future Outlook

As 2025 unfolds, REIT investors will navigate a landscape defined by evolving workplace norms and shifting capital flows. Office-focused trusts face a turnaround phase, with recovery hinging on the return of in-person collaboration and continued leasing in top-tier assets. Meanwhile, sectors such as industrial, data centers, and residential are poised to deliver growth in line with, or above, broader market averages.

The current environment presents both challenges and opportunities. Office REITs with strong balance sheets can seize acquisition opportunities at distressed valuations, while diversified portfolios can capture upside in resilient sectors. By combining strategic asset allocation with diligent risk monitoring, investors can position their REIT holdings for long-term success in a post-pandemic economy.

In summary, the narrative of REIT underperformance as office demand shifts is not a tale of uniform decline, but rather a catalyst for innovation and strategic realignment. Those who embrace the changing dynamics stand to reap the rewards of a more diversified and digitally enabled real estate universe.

Robert Ruan

About the Author: Robert Ruan

Robert Ruan