The commercial real estate market in the U.S. continues to face significant headwinds as 2025 unfolds. While the market showed signs of resilience after the initial shock of the COVID-19 pandemic, challenges like remote work, rising interest rates, and economic uncertainties are reshaping the sector. Office buildings are particularly affected, and many landlords and developers are reconsidering their strategies to adapt to a new normal that is very different from the pre-pandemic days.
Interest Rates and Commercial Real Estate: A Perfect Storm
The Federal Reserve’s policy on interest rates is one of the central forces influencing the commercial real estate sector. Over the past two years, the Fed has significantly raised interest rates in response to inflationary pressures, and as of June 2025, the federal funds rate hovers around 5.5%. This represents a sharp increase from the historically low rates seen in the early 2020s.
For commercial real estate developers and property owners, higher interest rates have created several challenges. First, financing costs have soared, making it more expensive to take on new projects or refinance existing debt. The cost of construction has also risen due to increased prices for materials and labor, further dampening developers’ enthusiasm to move forward with new commercial buildings. In addition, the commercial mortgage-backed securities (CMBS) market, which plays a key role in financing commercial properties, has become more volatile, as investors are now more cautious due to higher borrowing costs.
The Remote Work Phenomenon and Its Impact on Office Demand
One of the most significant structural shifts in the commercial real estate market has been the rise of remote work. While office demand was already shifting prior to the pandemic, the rise of hybrid work models—where employees split their time between the office and remote locations—has drastically reduced the need for office space.
Major companies like Meta, Salesforce, and Twitter have all adopted hybrid or fully remote work policies, drastically altering the commercial real estate landscape. As of mid-2025, office vacancies in large urban markets like New York City, San Francisco, and Chicago have continued to climb. According to CBRE, the office vacancy rate in the U.S. reached a 20-year high in early 2025, with vacancy rates above 20% in several large cities.
While some companies are encouraging employees to return to the office, the overall demand for large office spaces remains subdued. Many businesses are scaling back their office footprints, opting for smaller, flexible spaces or embracing fully remote operations. The flexible workspace industry, led by companies like WeWork and Spaces, has seen a resurgence, as businesses look for short-term leases and collaborative environments that offer flexibility.
Repurposing Office Space: A Growing Trend
In response to the growing office space glut, developers are increasingly looking to repurpose older office buildings into other types of properties, particularly residential units. The U.S. housing crisis, particularly in cities like San Francisco, Los Angeles, and New York, has prompted calls for creative solutions to address the shortage of affordable housing. Repurposing underutilized office buildings into residential properties or mixed-use developments is seen as an effective way to address both the oversupply of office space and the growing demand for housing.
One of the most significant examples of this trend is San Francisco’s Office Conversion Ordinance, which was passed in 2024 to incentivize the conversion of office buildings into residential units. The ordinance aims to convert up to 10 million square feet of office space into affordable housing, with a focus on creating new homes for middle-income workers.
In other markets, developers are also repurposing office spaces into co-living spaces, which have grown in popularity among younger generations who prefer affordable, community-oriented living. These changes reflect a shift toward sustainability and adaptive reuse as commercial real estate evolves to meet the needs of a changing workforce and housing market.
Challenges Ahead for Commercial Property Investors
Despite the growing trend of office conversions, the future of the commercial real estate sector is still uncertain. Investors and property owners are facing several risks as they navigate the evolving market conditions. For example, with office demand remaining weak and retail properties continuing to face challenges due to e-commerce growth, investors are being cautious about where to allocate their capital.
At the same time, industrial real estate—driven by e-commerce and the demand for warehouses and distribution centers—has emerged as one of the strongest segments in commercial real estate. According to CBRE, the industrial sector in 2025 saw continued growth, with vacancy rates falling to an all-time low of 4%, driven by robust demand for logistics and fulfillment centers.
Conclusion: Commercial Real Estate’s Evolving Landscape
The U.S. commercial real estate market is undergoing a significant transformation, influenced by a range of factors including remote work, higher interest rates, and the increasing demand for flexible spaces. While office space demand remains under pressure, the industrial and residential sectors are thriving, and there is growing interest in repurposing underutilized office buildings into new uses.
For developers and investors, success in this changing environment will require adaptability and foresight. Those who can capitalize on the trends towards mixed-use developments, residential conversions, and flexible spaces will be well-positioned to succeed in the post-pandemic real estate market.
