Office Building Owners Struggle to Stay Afloat Amidst Falling Demand and High Interest Rates in 2023

Office building owners, hit by falling demand and high interest rates, struggled in 2023, but mostly They managed to stay afloat. That it’s going to be much more difficult next year.

Many homeowners have been able to expand their loans, often by putting up more equity. But many of those extensions expire nowand the owners are losing hope that the occupancy rates rebound soon.

That means many more office owners they will be forced to pay their mortgages, sell their properties at a steep discount or hand over their buildings to their creditors.

“In 2024, it will be the moment of truth“said Scott Rechler, CEO of RXR Realty, a leading owner of office buildings in the New York region. “Owners and lenders They are going to have to reach an agreement about where the values ​​are, where the debt needs to be, and right-sizing the capital structures for these buildings to be successful.”

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The demand for offices shows no signs of returning to pre-pandemic levels. Although the number of full-time remote employees has decreased, hybrid workplace policies appear to be here to stay. In the fourth quarter, 62% of US companies allowed its employees to work from home some days a week, up from 51% in the first quarter, according to Scoop Technologies.

Return to office fees they also stagnated for most of 2023. Kastle Systems, which tracks security card usage in 10 large U.S. cities, said average office attendance is about at half its pre-pandemic level. Placer.ai, which tracks mobile phone data, puts it between 60% and 65%. But he also claims that the rate of return has peaked.

The office market has shown “some monthly fluctuations, but few real changes in the overall trajectory,” Placer.ai states in a November report. The empty office rate in the United States stands at a record 13.6%, up from 9.4% at the end of 2019, according to data firm CoStar Group. The firm is forecasting that it will increase to 15.7% by the end of 2024 and reach a maximum of more than 17% at the end of 2026.

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This vacancy rate is about to increase because nearly half of office leases signed before the pandemic have not yet expired, according to CoStar. When they do, many of the companies will probably occupy less space than they currently occupywhether they renew or move.

Take the case of the Chicago law firm Neal Gerber Eisenberg, which signed one of the city’s largest office leases for 2023 earlier this fall. The firm, which has continued to grow during the pandemic, adopted a policy that requires employees to work from the office at least eight days a month. Neal Gerber rented 90,000 square feet in its new location, a figure less than the 113,000 square feet that it will give up.

Beyond the long-term decline in demand, office lessors continue to face high interest rates. Landlords who have to refinance debt incurred when rates were at historic lows will face much higher borrowing costs, as the high vacancy rate is putting pressure on rents and rents. In recent weeks, inflation has decreased and Federal Reserve likely to ease interest rates in 2024. That will soften the blow. But the landlords continue to suffer financial difficultiesaccording to analysts.

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“If you have a mortgage that matures at 3% or 4%, There is no way to refinance at 3% or 4%,” says Steve Sakwa, an analyst at Evercore ISI. He adds that, although rates have fallen, to refinance a mortgage homeowners still have to pay rates that They could be double those that expire.

Not all indicators show problematic results for the office market in 2024. In many markets there is still a strong demand for spaces of the highest quality and best locations from tenants willing to pay high rents to encourage employees to return to the offices. Developers have withdrawn from new construction in the sector, so there is little competition from new offerings. The 30 million square feet of office construction started in 2023 was the lowest amount since 2010, according to CoStar.

Cities like San Francisco, New York and Boston are reducing costs and streamlining the conversion process of obsolete office buildings into apartments. Although this is not expected to translate into a large decrease in unemployment, the measures could bring more activity to commercial districts, giving a psychological boost to downtown homeowners and businesses.

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But the growing number of owners who They do not pay their mortgages due to falling rents looms over the market. The default rate on bank loans and loans converted to commercial mortgage-backed securities currently exceeds 6%up from less than 1% before the pandemic, according to data company Trepp.

The high default rate, together with the gloomy outlook for the offices, has already convinced some owners of return the properties to the lenders or sell them at very discounted prices.

In Stamford, Connecticut, the owner of One Stamford Forum, a 500,000-square-foot building whose tenants include troubled Purdue Pharma, returned the building to its creditors this fall, according to Trepp. In San Francisco, buyers have snapped up office buildings such as 60 Spear Street and 350 California Street for fractions of what they were worth before of the pandemic.

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Trepp predicts that the delinquency rate of the offices could exceed 8% in the second half of next year. As the number of defaulting owners increases, it is likely that new owners who will replace them—buying at greatly reduced prices— put more pressure on the marketsince they will be able to charge lower rents and still make profits.

“What could be catastrophic is that the pressures on corporate profits cause a continuous or accelerated pace of office reduction“warns Stephen Buschbom, Director of Research at Trepp.

*Content licensed The Wall Street Journal.

2023-12-20 04:10:32
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