Downtown Office Real Estate Suffers as New Neighborhoods Take Off

The sun-splashed streets of Los Angeles’ Century City evoke the prestige associated with the world’s entertainment mecca.

The aptly named Avenue of the Stars teems with traffic to the headquarters of Creative Artists Agency, talent manager for celebrities such as Brad Pitt, Steven Spielberg and Zendaya. LA’s wealthiest discreetly hand their cars off to valets at the offices of UBS Private Wealth Management and Goldman Sachs Group Inc. Cranes are hoisting I-beams for a new 37-story tower that will be the future home of CAA, law firm Sidley Austin and private equity manager Clearlake Capital Group.

It’s a starkly different scene 10 miles to the east, in LA’s downtown core. Buildings are losing tenants and going into foreclosure, with the area’s biggest commercial landlord — an affiliate of Brookfield Corp. — defaulting on $2.2 billion of mortgages since last year. Tent camps dot the streets in the epicenter of the city’s homelessness crisis. Oceanwide Plaza, a graffiti-covered project abandoned by a Chinese developer, is headed for a bankruptcy auction in September.

Such disparities are unfolding across the US, exposing deep divides in the commercial real estate market and the recovery of cities after the pandemic. From LA to Chicago and Boston, aging business districts are contending with empty offices and a slow return of workers, while neighborhoods just miles or even blocks away are faring better — or even thriving.

“We use the term ‘flight to quality’ often,” said Kevin Bender, executive managing director at Jones Lang LaSalle Inc. in LA. “It’s a movement not only to trophy assets, but also to more of a trophy environment.”

It’s a key to understanding the turmoil rocking the US commercial-property market, where big landlords including Brookfield, Blackstone Inc. and Starwood Capital Group have walked away from older downtown towers and foreign investors from South Korea to Germany have been burned by bad bets on what was once seen as a safe, high-yielding investment. Office values in US central business districts have plunged 52% from their highs, according to MSCI Inc., with San Francisco, Manhattan and the core areas of Washington and Boston posting some of the biggest price declines among global metropolises since the pandemic.

Nationally, the drop in values from the peak is much smaller — 18% — in US markets classified as suburban, or areas that are outside the traditional core. And in high-demand neighborhoods such as Century City, investor dollars continue to flow.

Even as many cities have returned to post-pandemic normalcy and employers have enacted stricter in-person work policies, office-rent growth in the central business districts of cities such as LA, Dallas and Seattle have lagged behind outlier areas, according to brokerage Savills. Companies trying to get employees back to their desks are instead paying top dollar for addresses in low-crime neighborhoods, with nearby parks, fitness centers, shopping, restaurants and entertainment. That’s creating a paradox of high vacancy rates in many markets, yet not enough of the type of space tenants want, said David Lipson, head of Savills North America.

About $557 billion of value was erased from US offices from 2019 through 2023 because of falling demand, with older, lower-quality properties disproportionately affected, according to a recently updated estimate by economists at Columbia and New York universities. At the same time, only 2% of the country's office buildings are considered to be top-tier — and they charge rents that average 84% more than the rest of the market, CBRE Group Inc. data show.

Investors are “indiscriminately putting all office in the same bucket,” said Rich Hill, head of real estate research at Cohen & Steers. “Office isn’t going away. The market is missing potential opportunities that might be beginning to emerge.”

Cities, of course, have always had certain neighborhoods that are more prestigious than others. Office rents in Manhattan’s financial district, for instance, have long been lower than those in Midtown.

But the plight of downtowns marks a reversal from the years before the pandemic, when tech and finance companies bet on offices in urban centers such as San Francisco, where high-cost young talent wanted to live. With vast amounts of office space now available, employers are shunning neighborhoods seen as partially empty or struggling with crime, according to Kate Collignon, an Oakland, California-based managing partner of HR&A Advisors, an urban-development consulting firm.

“The top-tier buildings have a brand value to them and an experience that makes it easier to get your workers in and easier to sell yourself as an employer in a tight labor market,” Collignon said.

As a result, districts that were the thriving centers of industry for decades are rapidly shifting. In Chicago, the area known as the East Loop has struggled with record vacancies and a slow return to offices. Ken Griffin’s Citadel, once a top employer, moved its headquarters to Miami, vacating part of its skyscraper.

The East Loop’s decline has been in the making for some time, but has accelerated in recent years, said Kyle Harding, a Chicago-based managing director for JLL. The greatest challenge to landlords, he said, is that its location is relatively far from the commuter hubs of Union Station or Ogilvie Transportation Center, where the suburban Metra trains run into the city. That makes it more difficult to lure in people accustomed to working from home.

By contrast, the West Loop, bound to the east by the Chicago River and to the west by Ashland Avenue, is holding up better. The neighborhood has newer and amenity-rich buildings, and includes the Fulton Market District, which has some of the city's top restaurants, hotels and retail. Asking office rents are more than 20% higher than in the nearby Central Loop.

BMO Financial Group moved its 3,400 Chicago employees to a new US headquarters in the West Loop, leaving a cluster of historic buildings in the heart of downtown that sold for a loss and are now part of a redevelopment project. The new tower, at 320 S. Canal St., has naturally lit interiors with collaborative work spaces designed to woo employees to their desks. It also has an outdoor green space for a weekly farmer’s market. The old offices were a 15-minute walk to the nearest park.

“We really do want people to come back,” said Larissa Chaikowsky, BMO’s US chief of human resources.

The move to a swank new building highlights another reason for the divide: Downtown districts that for decades have been the center of business tend to have older buildings. Landlords of aging properties are often unable to compete because costs for renovations, insurance and energy have soared while lenders have pulled the plug on office financing, according to Ruth Colp-Haber, chief executive officer of Wharton Property Advisors, a New York brokerage.

“What we have left are older buildings, many in AAA locations, but facing a tsunami of trouble,” she said. “It used to be there was plenty of business to go around. Now it’s a zero-sum game.”

The divides of old versus new are apparent in Boston, where the Seaport — a glittering waterfront district of towers that have largely been built over the past 15 years — is in high demand. At the end of the second quarter, less than 10% of the top-quality Class A office space in the Seaport was available, according to Colliers, while more than 25% of comparable-caliber space in the financial district was available.

On a summer Friday, tourists, residents and office workers flocked in and out of the Seaport’s Warby Parker and Lululemon stores and grabbed lunch at one of the many restaurants filling new retail real estate. The neighborhood is home to Boston Consulting Group, industrial software company PTC Inc. and the Boston Convention and Exhibition Center. It also reflects Boston’s growing stature as a biotech hub: Vertex Pharmaceuticals Inc. is based there, while Eli Lilly & Co. recently opened its Lilly Seaport Innovation Center in the district.

In Boston’s financial district, home to the regional Federal Reserve bank and old-line firms such as Fidelity Investments, just about every block has a sign advertising retail or office space. Bank branches have closed, as did a flower store, an Italian restaurant, a card and tobacco shop and Hyde Leather & Shoe Repair. Sweetgreen and Cava have lunchtime lines, but that’s partly because many of their would-be competitors have shuttered.

One benefit of city centers is they tend to be closer to nightlife, which has revived to pre-pandemic levels in many downtowns, including those where offices have gone dark, according to Karen Chapple, director of the School of Cities at the University of Toronto, who analyzes cellphone activity in urban areas to measure foot traffic. Signals after business hours have exceeded pre-pandemic rates in downtowns including LA, Miami and Houston, Chapple’s research found. Entertainment, dining, medical services and higher education opportunities are more likely to enliven streets these days than 9-to-5 white collar jobs, she said.

In Seattle, access to nightlife is a draw for young residents, said Bill Cooper, a CBRE senior vice president. Yet tech companies have been migrating away from downtown to the eastern suburb of Bellevue, where taxes and crime are lower. Pokémon scooped up nearly 375,000 square feet of office space earlier this year, and TikTok owner ByteDance Ltd. signed a new lease for almost 133,000 square feet.

Amazon.com Inc. has been growing in Bellevue since clashing with Seattle leaders about a head tax on employees. While the e-commerce giant still has a huge presence in Seattle, the company now describes its base as the “Puget Sound Headquarters” and much of its headcount growth is planned for Bellevue.

“In considering Bellevue or Seattle, a lot of big companies are trying to figure out how to get people back to the office,” said Cooper, who’s based in Bellevue. “So if there’s any reason, it might be transit, lack of parking, safety, any of those things that an employee would not want to come in the office — I’ll call it a deterrent — that’s a big focus right now as we’re locating offices for people.”

Downtown Dallas, a traditional 9-to-5 office area, is losing out to Uptown with its round-the-clock mix of apartments, restaurants and entertainment. Rents there are twice that of downtown because of newer buildings, better parking, easy freeway and tollway access to suburban homes and greenery, said Bill Brokaw, senior vice president and leader of commercial real estate at Hillwood Urban, the office division of Ross Perot Jr.’s Hillwood real estate company. Goldman Sachs chose Uptown for a new campus set for more than 5,000 employees.

Savills North America is moving its Dallas offices about a mile next year to a new Uptown building from its current location in the Dallas Arts Tower, a 55-story skyline icon since 1987.

“You walk into that building and you’re depressed,” Lipson, the division’s New York-based CEO, said of the current Dallas office. “Where we’re moving is brand new and a world away in terms of the neighborhood and the energy.”

All of these factors — from sprawl to industry shifts to blight — are coming into play in LA. The divide between downtown and Century City’s office markets is “the most dramatic in the country,” said David Steinbach, global chief investment officer for Hines. The real estate company, which manages $93 billion in assets, saw the changes emerging in LA years ago and sold off its downtown properties while investing in the city’s west side.

Downtown LA’s office availability rate, including space for sublet, stood at almost 30% in the second quarter, up from 21% in early 2020, Savills data show. Only 15 Class A downtown buildings with space for rent are financially sound, while 10 others are in default, foreclosure or other stages of distress, according to a presentation by CBRE.

One symbol of downtown’s dashed aspirations is Oceanwide Plaza, now for sale, five years after the Chinese developer ran out of money after spending $1.2 billion. The site’s unfinished towers have been tagged by graffiti artists and lured bolder daredevils, including parachutists and a man who walked a slackline between two of the steel structures.

The decline also brings the opportunity for reimagination. Some downtown LA advocates argue the neighborhood is still fertile ground for creative workers in fashion, entertainment and the arts. Arizona State University restored an old newspaper office, and the University of California at Los Angeles bought a 1920s insurance building, bringing students to the area as office tenants exit. That’s the case in other cities, too: In Chicago, for instance, a Central Loop building is being redeveloped as space for Google, and several vacant office properties are being converted into apartments.

But the rise of outlier areas has something of a domino effect. As Century City becomes more of a center for the entertainment industry, the law firms that serve those clients are following. Skadden, Arps, Slate, Meagher & Flom is leaving downtown LA completely, relocating its staff to Century City. Sidley Austin is cutting its downtown office footprint by more than half while expanding to three floors in the tower under construction at 1950 Avenue of the Stars.

That building is slated to open in 2026. A block away, renovations are nearing completion for the new headquarters of Ares Management Corp. A subway station is scheduled to open on the corner of Constellation Boulevard and Avenue of the Stars before LA hosts the 2028 Olympics.

“It all came together at a great time,” said Patrick Meara, chief operating officer of JMB Realty, the developer of 1950 Avenue of the Stars. “Demand for the best buildings is just getting stronger.”