High Vacancy Rates

Owners of office buildings have been facing tough times since the Covid-19 pandemic began emptying their properties in early 2020. Data from the real estate consulting firm Colliers shows that the vacancy rate in the U.S. climbed from 11% at the end of 2019 to 17% today, which is higher than the peak during the 2008 global financial crisis (GFC).

  • Yet, surprisingly, there haven't been as many forced sales as one might expect. In 2023, distressed sellers accounted for only 3.5% of all office property transactions in the U.S., according to MSCI Real Assets.
  • This figure dropped to 2.7% in January. This is a stark contrast to the quick escalation of distressed sales during the GFC.

The economy's resilience is providing some breathing room, as most companies continue to pay their rent on time. However, as leases come up for renewal, a trend is emerging where companies are choosing to downsize their office space by 30% to 40%.

Kicking The Can Down The Road

Lenders are also playing a part in delaying potential crises. They're reluctant to push for sales in a struggling commercial real estate market, which would likely result in significant losses.

  • This reluctance is also evident in how debt maturities are being handled. For the $35.8 billion in office loans maturing last year in the commercial mortgage-backed securities market, only a quarter were fully paid off at maturity, reports real estate analytics firm CRED iQ.
  • Many loans were either extended or handed off to special servicers, which are third parties that seek out the best possible outcome for the debt, whether through renegotiated terms or foreclosure.

Office loans are more complicated now than they were back in 2008, making distressed sales more difficult. With more lenders involved, especially for large buildings owned by institutional investors, reaching a consensus on foreclosure or sale is challenging.

1929 For Offices

Out of approximately 600 defaulted office loans in the CMBS space sent to special servicers over the past two years, losses were realized on only five, according to CRED iQ. These properties were foreclosed on and sold.

  • There's growing interest from investors looking to capitalize on these conditions. Reven Capital is aiming to raise $1 billion for a fund focused on distressed office properties, with its founder calling the situation "1929 for offices.".
  • This sentiment is shared by major players like Blackstone, Brookfield, Cohen & Steers, and SL Green Realty, who are all investing in distressed real estate lending, despite some of them also returning keys to their own properties.

While these investments might slow the rate of forced sales in some instances, the overall financial needs of the office sector are expected to far exceed available funding soon. CBRE estimates a $72.7 billion refinancing gap for U.S. office landlords through the end of 2025.

Prosperity Is Just Around The Corner...

The current lack of distressed sales could partly be due to hope for lower interest rates in the future, which would reduce the need for steep discounts on sales. There's also optimism that office demand might rebound, as seen in the high volume of office property purchases in 2021, according to MSCI Real Assets.

  • However, holding out comes with costs, such as insurance and maintenance expenses for potentially obsolete buildings. When distressed assets do finally flood the market, it's likely to put even more pressure on already declining office property values, which have dropped by 35%.
  • Yet, there's a belief that this could represent a significant investment opportunity, particularly in the right locations, according to Mike McDonald, a senior managing director at JLL. Early investors, including ultra-wealthy families and local developers, are already positioning themselves to snatch up bargains.

Despite the anticipation, the flood of "For Sale" signs in the office property market is taking longer to materialize than many had expected.


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Photo by Joël de Vriend / Unsplash.