Last year was a tumultuous year for commercial real estate in general, however, certain sectors are leading their peers as it relates to value, credit and outlook. Supplanted only by retail, office is leading the way down the devaluation path, with a variety of factors affecting the trend. As of December 2022, out of nine regions, the Midwest region is the fourth worst or sixth best (for the optimists) as it relates to lender risk ratings in the office segment.
We all know the macroeconomic events of last year, so this article will not dwell on the past. Yet most office markets are anywhere from rippling to reeling due to the previous four quarters, and several regions will continue to come to grips with the sustained impacts of today. In June, Columbia University released its research concerning the office market. Extrapolating the data leads us to forecast an ongoing degradation in the office sector anticipating values may “reset” down 28 percent by 2029. According to Trepp research, the securitized market liquidated 149 loans resulting in $2.8 billion in recovery, but an overall loss ratio of 43.7 percent. The office market contained 27 of those loans with a value of $642 million and an overall loss ratio of 52.8 percent, the largest of which was a $107.1 million loan collateralized by the 1.5 million-square-foot AT&T Center in St. Louis. The property sold for $4 million, resulting in a total loss.
As we roll through 2023, we have yet another hiccup to consider and that is the sheer amount of maturities pending in the sector. The Wall of Maturities, totaling nearly $40.5 billion, is scheduled to mature in 2024, consisting of 353 loans backed by 583 office properties. Whether floating or fixed, rate shock at sale or refinancing will cause many of the properties to fall out of performing status unless significant capital is invested to correct loan-to-value ratios and debt service coverage ratios. One of the most poignant data points is that companies large and small are reducing their office footprints. We have heard about Facebook (Meta), Microsoft, Salesforce and other technology- based companies downsizing their workforce and leased portfolio.
But this trend is not limited to tech companies. Liberty Mutual, Boeing, www.REBusinessOnline.com Raytheon, Target, Nike, PwC and a variety of others are also joining in the efforts to reduce wasteful spending. Adding fuel to the fire is the continued embracement of work from home Mitch across the Midwest Doner coupled with very Bradley Co. few employers forcing employees to return to the office.
In a world of change, there is always opportunity along with strategy and concepts to alleviate some discomfort. The opportunities are varied but occur on all fronts. For tenants who need an office, the time to strike is open ended from now through the foreseeable future (2024). Locating alternative office locations within distressed pockets allows lease terms to be driven well into the tenants’ territory. The fine line between distress and going down in flames is sometimes hard to spot. When researching options for your clients, make sure the asset(s) you put forth are not so far down the trail that they cause issues, such as critical deferred maintenance or the asset’s ability to serve the needs of the client.
For investors, the options will continue to grow and open a world of assets, which may have seemed unobtainable. Working with a variety of stakeholders allows you to create solutions to otherwise insurmountable obstacles. Due diligence is key, Pan Am Tower in downtown Indianapolis was purchased out of foreclosure from John Hancock Financial. as along the way to foreclosure, many items are swept under the rug or buried in concrete. To the users who no longer need an office and the owners and investors who maintain large office holdings: don’t fool yourself. Rip off the bandage, address the issues and be on the front end. Those who survived the Great Recession may remember how those first to the table were treated versus those who hid and were not forthcoming. Last, but not least, to our friends on the brokerage market: don’t retreat Inc. too far from the front lines. The market needs the help of professional brokerage services more than ever. Navigating the macro market is somewhat less difficult today than in the past, but nothing is more valuable than the local professional who can tell you why this is happening to your asset or others.
Jonathan M. Hardy is a Senior Managing Director and PrincipalMitch Doner is a Vice President, Director of Asset Resolutions and Managing Broker with Bradley Co. in Indianapolis.
