U.S. Commercial Real Estate Faces First Contraction in 25 Years

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U.S. Commercial Real Estate Faces First Contraction in 25 Years

The U.S. office space market is shrinking for the first time since 2000 due to rising demolitions, residential conversions, and declining new construction. This shift may benefit tenants but puts pressure on REITs and traditional real estate investors.

Sultan Sikander

June 18, 2025

4Min Reads

Finance Insights

U.S. Commercial Real Estate Faces First Contraction in 25 Years – Full Report

The American skyline is undergoing a historic transformation. For the first time in a quarter-century, the total office space in the U.S. is not growing—it’s shrinking. More square footage is now being removed through demolition and conversion than is being newly constructed. This shift marks a milestone in the commercial real estate sector and reflects broader economic and social transformations driven by changing work habits, remote office culture, and urban reinvention.

1 – Shrinking the Supply Chain

In 2025, approximately 23.3 million square feet of office space are being removed from the national supply. Of this, 12.8 million square feet are being converted—largely to residential or mixed-use spaces—and 10.5 million are being demolished. In stark contrast, only 12.7 million square feet of new office construction is expected this year. This is one of the lowest totals in decades, a clear reflection of fading investor appetite for traditional office buildings.

2 – Why Office Buildings Are Being Removed

Many office buildings constructed in the 1970s and 1980s are now considered outdated. Their wide floor plans, aging infrastructure, and poor energy efficiency make them unsuitable for modern tenants. Renovating them is expensive. In many cases, it’s cheaper and more profitable to demolish or convert them. Additionally, the pandemic accelerated hybrid and remote work trends, reducing the demand for large, centralized offices.

3 – The Rise of Office-to-Residential Conversions

One of the most prominent trends is the conversion of office buildings into residential units. Cities like New York, Washington D.C., Cleveland, and Cincinnati are leading in this area. Manhattan alone is targeting over 40 million square feet for conversion over the next decade. These projects are supported by zoning flexibility and government incentives aimed at easing housing shortages.

4 – Vacancy Rates Remain Stubbornly High

Even after years of adjustments, the national office vacancy rate remains between 19% and 19.5%. In some urban cores, it's even higher. While leasing activity has shown slight recovery—rising by 18% in the first quarter of 2025—new demand is not strong enough to offset the massive oversupply left from the pre-pandemic era.

5 – Construction Pipeline Hits Historic Low

Office construction activity has slowed dramatically. Only 2.8 million square feet of new office starts were recorded through April 2025. This is the slowest construction pace in over a decade. Developers are focusing on adaptive reuse and targeted sectors like industrial parks, data centers, and mixed-use spaces.

6 – Investor Sentiment: Defensive and Selective

Commercial real estate investors are rebalancing portfolios. Most are shifting away from traditional office buildings and toward industrial real estate, multifamily housing, and specialized sectors like healthcare and logistics. Publicly traded REITs with high exposure to urban office space are underperforming. However, those investing in residential conversions or suburban mixed-use hubs are seeing improved returns.

7 – Banking Sector Tightens Lending

CRE lending has dropped significantly. Many banks are reducing exposure due to rising defaults and the uncertain value of office assets. About $1 trillion in commercial real estate debt is maturing in 2026, with nearly 8% of that tied to office buildings. Refinancing this debt will be challenging, especially if interest rates remain elevated. Some experts are forecasting a rise in distressed property sales as a result.

8 – Spotlight on Cities

Urban centers are being forced to rethink zoning and development strategies.

In Orange County, only 0.17 million square feet are being built while over 4.2 million are planned for conversion.

In Washington D.C., multiple aging buildings have already been repurposed for housing and education purposes.

In Cleveland, the focus is on revitalizing downtown through incentives for adaptive reuse.

This local-level transformation is reshaping the commercial footprint across the U.S.

9 – Economic Impact Beyond Real Estate

The contraction in office space doesn’t only affect property values—it impacts employment, tax revenue, transit use, and small businesses. Empty buildings reduce downtown foot traffic, hurting restaurants, shops, and service providers. Cities may need to adjust budgets to account for declining property tax income and invest in new infrastructure to support residential influxes.

10 – Symbolic Meaning of the Shift

This trend symbolizes more than just market mechanics—it represents a change in societal priorities. Office buildings once stood as symbols of corporate dominance. Today, their hollow halls are being repurposed into homes, schools, and creative spaces. It reflects a pivot from rigid systems to flexible, people-centered environments. The skyline is no longer about height—it’s about adaptability.

11 – Investor and Stakeholder Tips

– REITs & Investors:

• Diversify into non-office assets.

• Consider indirect exposure via funds focused on conversions or redevelopment.

– Cities & Policymakers:

• Provide tax incentives and relaxed zoning for conversion projects.

• Strengthen infrastructure to support increased residential density downtown.

– Tenants & Occupants:

• Negotiate shorter leases or flexible contracts.

• Focus on hybrid models and tech-enabled spaces.

– Banks & Lenders:

• Conduct stress tests on office loan portfolios.

• Extend repayment terms or explore debt restructuring where needed.

12 – The Road Ahead

The commercial real estate market is entering a new era. While the contraction of office space signals challenges, it also presents opportunities. Those who adapt—by rethinking use, embracing mixed models, and aligning with social needs—will thrive in this next chapter. The shift may seem disruptive, but it’s ultimately constructive. America’s cities are not shrinking—they’re evolving