Challenges remain for the beleaguered asset class
The woes of the office space have been a constant theme in the US commercial market of recent years – and that shows little sign of abating anytime soon as lenders continue to view the sector with caution.
For Alex Horn (pictured top), managing partner and founder at private lender BridgeInvest, the office space is currently marked by an “asymmetric risk-return position” that requires a significant shift for things to balance out. Put simply: “There’s just too much office in this country for the amount of people that actually need to be there,” he told Mortgage Professional America.
That growing trend was, of course, exacerbated by the remote-working revolution that gathered pace at the onset of the COVID-19 pandemic as offices shuttered and huge swathes of the American workforce started to work from home.
It’s also one that could have some way to run yet, according to Horn, meaning that lenders prefer a “wait-and-see” approach rather than diving in before the fog clears.
“Our habits in the United States have changed and in turn our office use has changed. And so office is going to go through a reckoning for the next two to five years, right-sizing,” he said.
“Being a lender in that space, it’s rare that it makes sense to take that risk return. Because ultimately, if you’re betting wrong, you have a real likelihood of lending on a functionally obsolete and really impairing the principal of a loan.”
Are there upsides for buyers in the office space at present?
While a sizeable percentage of current office supply in the US is excessive and needs to be removed, Horn said there are still opportunities for the right buyers to come in and purchase at deep discounts, underwriting to a certain degree of market destruction.
If, for instance, that market destruction amounted to 20%, a buyer who purchased 10 buildings could still see fair value for their investment. “If you have eight home runs and two bad ones, they’re pretty easy calculations,” Horn said.
Greg Friedman, CEO of Peachtree Group, forecasts a prolonged shift in the commercial space with continued repricing across asset classes and cap rate expansion.https://t.co/ECBAX5x3kG#mortgageindustry #commercialmarket #mortgagerates
— Mortgage Professional America Magazine (@MPAMagazineUS) March 19, 2024
“There’s a lot of people that are going to do that and say, ‘Hey, I can raise the capital to buy these properties unlevered and hold them and eventually make a lot of money out of that.’”
Still, while there are plenty of buyers willing to gamble on making the right bet in the office space, it’s much harder for lenders to ascertain whether that bet is a reasonable one, he added.
No sign of fog easing in the office market for now
Colliers painted a gloomy picture for the office market’s outlook heading into 2024, noting in its Q4 report that the sector had “limped” into the prior year and shown little indication of improving prospects anytime soon.
Throughout 2023, office vacancy jumped to 16.9%, bringing it above the highs reached during the global financial meltdown of 2007-08, while growing optimism on the overall economic front was not mirrored in the office space.
That’s partly because of the sluggish pace of return-to-office efforts across the board. “Despite CEOs’ desires, the slow and deliberate return to onsite office work appears to be moderating,” Colliers indicated.
“While it appears most tenants are adopting hybrid working with a minimum of three days a week in the office, tight labor conditions continue to give employees the upper hand, making it difficult for CEOs to push for more office days in the hybrid tug-of-war.”
Asking rents in the office space for downtown class A types dipped by 1% in Q4 2023, to $53.55 per square foot per year, while suburban class A types saw a 2.1% increase to $35.15.
Many large occupiers could reduce office space by between 20% and 30% in 2024, the report added, with vacancy rates set to continue rising – particularly for older and outdated assets – and lease rates expected to experience downward pressure.
What’s more, a coming $2.8 trillion of loans across all asset classes due by 2028v will see distress rise and a difficult choice for many borrowers between putting more capital into assets or “handing the keys back.”
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