Latest / Bull Market Conversations with Fexingo: Rallies, Momentum, and Riding Market Strength / How Bull Markets Are Reshaping the Urban Office REIT
Transcript
- Lucas: Luna, there is a corner of this bull market that barely gets mentioned on financial TV, and it's sitting right in the middle of every major downtown. Urban office REITs — the ones everyone wrote off during the work-from-home panic — are quietly having their best year since 2019. Luna: I've seen the headlines about Goldman and JPMorgan calling people back five days a week, but a REIT recovery that's actually showing up in the numbers? That's a different story. What are we looking at specifically? Lucas: Let's start with one concrete data point: Boston Properties, ticker B-X-P, the largest publicly traded owner of Class A office space in the U.S. Their flagship tower in midtown Manhattan just reported occupancy above 80 percent for the first time since March of 2020. That building was at 62 percent occupancy eighteen months ago. Luna: Eighty percent is not full — but it's a huge swing. And I'm guessing the rent growth on those new leases is meaningful too. Lucas: It is. The average starting rent on new leases in that building is now $95 per square foot, up from $82 in 2023. And it's not just Boston Properties. The Vanguard Real Estate ETF, V-N-Q, which has a heavy REIT allocation, is up 12 percent year to date. The S&P 500 meanwhile is at 7,544 — up about 10 percent. So real estate is actually beating the broad market this year. Luna: That is interesting. Because if you look at the Russell 2000, the small-cap index, it's only up about 4 percent in that same period. So office REITs are outperforming both big caps and small caps. What changed? Lucas: A couple of things. First, the return to office mandates became real enforcement, not just aspirational language. Goldman Sachs told its 45,000 employees in January that they need to be in the office five days a week. JPMorgan followed in March. And when the two biggest banks in the country do that, every law firm, every consulting firm, every hedge fund that wants to recruit their talent has to match. Luna: And that's driving physical demand for downtown space. But there's also a financial reason, right? The Fed funds rate has been sitting at 3.63 percent since June, and the interest on reserve balances is 3.65. That stability matters for REIT financing. Lucas: Exactly. REITs are basically leveraged real estate portfolios. When rates are volatile, their cost of capital jumps and the math on acquisitions gets ugly. But with the Fed pausing — and Chairman Kevin Warsh even hinting at a 'regime change' in his testimony yesterday — the market is pricing in a stable or even lower rate environment. That allows REITs to refinance maturing debt at predictable rates. Lucas: And by the way, the GDP backdrop supports this. Real GDP growth annualised came in at 2.1 percent for the first quarter of 2026. That's not booming, but it's solid. And nominal GDP is now above $31.8 trillion. Corporate profits are strong enough to justify premium office space. Luna: So the macro is supportive. But I want to push back a little on the narrative that this is a broad recovery. Because if you look at the ARKK innovation ETF, it's actually down 0.8 percent in the last five days. Tech darlings like Shopify and CrowdStrike are up huge — 5 and 10 percent respectively — but that's a different part of the market. Is the office REIT rally concentrated in a few trophy buildings, or is it actually broad-based? Lucas: Fair question. The data shows the recovery is tiered. Class A buildings in the central business districts of New York, San Francisco, and Chicago are seeing occupancy gains. Class B and C buildings in suburban office parks are still struggling, with vacancy rates above 20 percent. So it's not a rising tide that lifts all REITs. But the index level move — the 12 percent year-to-date gain — is driven by the biggest names, which are mostly Class A. Luna: And that's partly because the AI boom is creating new demand. I read that Goldman and JPMorgan are both expanding their AI research teams, and those teams want open-floor, high-tech spaces in downtown cores. That's a specific tailwind that wasn't there in 2023. Lucas: Exactly. And by the way, that's the kind of specific demand that shows up in the numbers already. The national downtown office vacancy rate dropped below 15 percent for the first time in May 2026, according to CBRE. That's down from a peak of 19.6 percent in early 2024. So the trend is real, even if it's uneven. Lucas: Now, here is where I want to be careful. A listener might hear this and think 'I should go buy an office REIT ETF.' And maybe that's a reasonable trade. But there's a specific risk that the market is not fully pricing in, which is the Warsh 'regime change' comment. If the Fed actually cuts rates later this year, that's good for REITs. But if Warsh is signaling a more hawkish stance — meaning rates stay higher for longer — then the refinancing risk for REITs with floating-rate debt could resurface. Luna: So the bull case depends on rate stability, not necessarily rate cuts. But you mentioned a flagship building at 80 percent occupancy. What's the path to 90 or 95 percent from here? Is that realistic in this cycle? Lucas: It depends on the market. In New York, Manhattan office absorption — that's net new space leased — has been positive for six straight quarters. At the current pace, 90 percent occupancy for top-tier buildings is achievable by mid-2027. In San Francisco, it's slower because tech companies still have more remote flexibility. But even there, the AI firms are leasing space at a rate that surprises me. Luna: And that brings up another angle: the AI revolution is not just about software. It's about physical infrastructure. Data centers get all the attention, but AI companies also need office space for their growing workforces. CrowdStrike, Datadog, Cloudflare — they're all leasing more square footage in 2026 than they did in 2024. Lucas: That's a great point. And it's not just the cloud security names. Shopify, which is up 5.4 percent in the last five days, just signed a 200,000-square-foot lease in downtown Ottawa. That's a company that was fully remote in 2020 and 2021. So the pendulum is swinging back. Lucas: But I think the most important number for the listener to hold onto is this: the ten-year Treasury yield is still around 4.2 percent. The dividend yield on the average office REIT is around 4.5 percent. So you're getting a slight premium over bonds, plus the potential for rent growth. That's the math that's attracting income-oriented investors back into the space. Luna: So the risk-reward is actually decent as long as the economy doesn't tip into recession. And with 2.1 percent real GDP growth and stable rates, recession doesn't seem imminent. But I want to ask about the bear case. What would break this recovery? Lucas: A few things. One: a sudden spike in unemployment that makes companies reconsider their office footprint. Two: a surge in remote work friendly legislation — though that seems unlikely with the current political winds. Three: a credit event where a major REIT can't refinance its debt and has to sell assets at distressed prices. That hasn't happened yet, but the risk is always there. Lucas: Also, there's a structural change happening that could cap the upside: companies are using less square footage per employee. Even with return to office mandates, many firms are adopting hot-desking and shared workspace models. So the total office square footage demanded may never return to 2019 levels, even if occupancy rates improve. Luna: That's the nuanced take. The bull market in office REITs is real, but it's a selective recovery. The trophy buildings in the best locations with the best tenants are going to outperform. The rest of the market might just tread water. Lucas: Right. And that's exactly the kind of specific, data-driven conversation we try to have on this show. If you've been thinking about your own portfolio and wondering whether commercial real estate belongs in it — or if you just find this corner of the market fascinating — we've got a way to keep these conversations going ad-free. Luna: Yeah, a small group of listeners makes that possible. It's not a big thing, but it matters for us. If our office reit deep dive or any of our other episodes have helped you think about investing differently, you can find us at buy me a coffee dot com slash fexingo. That's all lowercase. Lucas: And we mean it — that support is literally what lets us spend the time digging into the data on things like Boston Properties' occupancy rates or the Fed's 'regime change' language. We don't run ads, we don't have sponsors, and that's because of that listener community. So thank you. Luna: Absolutely. And now, back to that flagship building — Lucas, you mentioned 80 percent occupancy. What's the next catalyst that could push that number higher in the second half of 2026? Lucas: The next catalyst is lease expirations. A lot of the leases signed during the pandemic at discounted rents are rolling off in late 2026 and early 2027. Landlords are going to push hard for market-rate renewals. If the economy stays firm, those renewals should come through at higher rents, which directly boosts funds from operations — the key metric for REITs. Lucas: And there's a specific event to watch: the expiration of the lease on a major law firm in that Boston Properties tower. That lease is up in November 2026. If they renew at current market rents, expect the stock to pop. Luna: So there are specific milestones to track. That's the kind of granularity that makes this show useful. Alright, let's leave it there for today. Next time we'll dig into another overlooked corner of this bull market. Lucas: Sounds good. And as always, thanks for listening. If you want to support the show, you know where to find us — buy me a coffee dot com slash fexingo. See you next time.