Archives for February 2024

Office inventory is holding steady or shrinking in select cities across the country, due in part to an increase in conversion projects and a slowdown in new construction.

That’s according to a recent analysis by Savills, which found office inventory shrank in seven metro areas tracked by the commercial real estate firm. Those markets are Washington, D.C., as well as the adjacent northern Virginia and suburban Maryland markets; New York; Phoenix; Orange County, California; and Baltimore, which saw its inventory shrink the most, by 3.2%.

The analysis examined office inventory between the fourth quarter of 2022 and the final three-month period of 2023.

Notably, though, more metro areas examined by Savills posted gains in office inventory, led by Salt Lake City and Austin, Texas, which posted 4% and 3.7% gains in office space, respectively, on a yearly basis. The Dallas-Fort Worth metro area and Seattle-Puget Sound followed, at 3.6% and 2.8%, respectively.

San Diego and Philadelphia saw their inventory remain unchanged year over year.

Michael Soto, senior director and head of office research at Savills, said the United States has been oversupplied on office space since even before the Covid-19 pandemic. Most markets seeing their inventory grow have projects that broke ground two or three years ago that delivered in 2023.

“Now there are redevelopment pressures in these markets to finally deal with some of the office stock that has long-term office vacancy,” Soto said.

The conversion of office space into a new uses — primarily residential — has become a hot topic of discussion as reduced office-use patterns become permanent, office buildings with high vacancy see their values decline, and massive loans those properties back reach maturity. Developers in some metro areas, including D.C., have completed conversions successfully for a long time and also have an abundant supply of buildings considered ideal for such conversions. Other cities that have seen little to no conversions historically are starting to develop policies and incentives around conversions.

Despite that uptick in conversion activity shrinking office inventory in a few places, most of the office markets analyzed by Savills are still considered oversupplied. The firm examined average square feet per office-using worker and average utilization levels nationally, determining 151 square feet per employee to be a national baseline.

Based on that, only three markets — Nashville, Tennessee; south Florida and Tampa-St. Petersburg, Florida — were considered undersupplied at the end of 2023. Boston, New York, and Raleigh-Durham, North Carolina, ranked as the most oversupplied.

Sublease space dips for first time in two years

For the first time since the fourth quarter of 2021, sublease inventory shrank nationally at the end of 2023, Savills found.

It went from 176.4 million square feet in Q3 2023 among markets tracked by the firm to 173.7 million square feet in Q4. Still, compared to 127.5 million square feet of sublease space on the market in Q4 2020, that market overall has continued to grow since the pandemic.

Soto said it was surprising to see sublease space decrease nationally at the end of 2023 but, he added, there were some high-profile subleases around the country in which the lease term expired, which meant that space turned into direct vacancy.

It’s a trend that could continue this year.

“We’re going to track this very closely in Q1,” Soto said. “Also, we have some issues where the subletters pulled (their space) off the market — whether it’s been on the market a long time or whether it’s, ‘Oh, we fired our sublease broker and we’re going to go back to the market down the road.’ … There’s some of that going on.

“I wouldn’t be surprised if it jumped back in Q1,” Soto said.

Tech-heavy metros like San Jose, California, and San Francisco led the way in sublease inventory in Savills’ research, with 35.8% of all available office space in the South Bay/San Jose area concentrated in the sublease market. In San Francisco, that share was 27% — a percentage also seen on the other side of the country, in tech-heavy Boston. The U.S. national share was 18.9% at the end of 2023.

The sublease market could become an increasingly attractive option for companies in the market for space, especially as fewer new, highly amenitized office towers that companies today desire break ground. Sublease activity made up about 12% of U.S. office leasing activity in the fourth quarter, compared to less than 10% earlier in the year, according to CoStar Group Inc. (Nasdaq: CDGP).

Soto said San Francisco is going through a generative artificial-intelligence startup boom, and some of those companies are turning to sublease space for their offices. At least two significant lease transactions in 2023 were sublease deals in the gen-AI space: OpenAI Inc.’s 486,600-square-foot deal and Anthropic’s 230,000-square-foot sublease, both in San Francisco.

“If you’re going into a sublease space, the space is already built out for you for the most part,” Soto said. “Theoretically, there should be minimal cost to build out. There could be a discount on the rent. We’re going to track that very closely.”

The biggest sublease deal in 2023, as tracked by Savills, was Walmart Inc.’s 718,651-square-foot deal in Sunnyvale, California.

Source: “Here’s where office space inventory is actually shrinking — and what’s driving the trend“

JPMorgan Chase (NYSE:JPM) CEO Jamie Dimon believes commercial real estate issues will only worsen if there is a recession, and a lot of property owners can handle the current level of stress.

“If we don’t have a recession, I think most people will be able to muddle through this, refinance, put more equity in,” he told CNBC in an interview.

Dimon noted that not all sub-sectors in commercial real estate are at risk, such as warehouses and data centers. “But if you take just offices, they’re worth less because of interest rates. When rates go up 300 basis points, whatever you own with the cash flow is worth 30% less. That’s not a crisis. That’s kind of a known thing.”

As for mounting defaults, Dimon said “part of that’s just a normalization process.” But “if rates go up and we have a recession, there will be real estate problems, and some banks will have a much bigger real estate problem than others.”

When asked about a soft landing for the economy, Dimon said markets are pricing in 70%-80% odds of that happening. “I give it half that. We may very well have one, but there’s also a higher chance than the market thinks of rates being a little bit higher.”

Commercial real estate has been an area of concern, amid fears that property owners may not be able to service debt payments, with $929B of outstanding commercial mortgages due this year.

Concerns escalated after New York Community Bancorp disclosed a massive provision for credit losses, given its outsized commercial real estate loan exposure.

Source: “JPMorgan’s Jamie Dimon isn’t too worried about commercial real estate“

When a Fortune 500 company puts a massive apartment portfolio consisting of 11,000 communities on the market, people take notice and ask questions.

“Investors can draw conclusions from the Lennar portfolio sale that even the largest operators become adversely affected by the changes in the construction debt market and loans coming due,” says David Evans, Kidder Mathews senior associate in Los Angeles. The massive multifamily sale was described as a tactical balancing of Lennar’s portfolio.

“With refinancing options requiring a significant amount of capital to be brought to the table, they preferred to take these properties to market versus reaching out to investors for capital for a cash refinance,” Evans adds.

Most of the Southern California Kidder Mathews executives GlobeSt. asked pointed to industrial as the property type more likely to trade when portfolio deal volume returns, followed by multifamily, self-storage, and retail. Industrial portfolios will continue to be sold direct to investment firms such as Prologis and Rexford, Evans notes. Rick Putnam, Kidder Mathews EVP in Orange County, has a different property type in mind though: “Primarily office, which is becoming more of a specialty niche due to ongoing capital requirements.”

Peter Quinn, SVP in Kidder Mathews’ San Diego office, sees lenders working with borrowers to minimize defaults when the wave of loan maturities comes. Putnam expects some large sales of Class B and C product as liquidity returns, “but these lumpy maturities are dealt with.” Evans asserts that new construction properties in markets that have been overbuilt, i.e., many of the Sunbelt states, will see some distress and lowering of values due to supply and demand imbalance. In markets short on supply, portfolio residential sales will continue to see high demand and strong pricing from investors.

“Regarding the wave of low maturities expected into 2024 and 2025, the view here is that with the exception of office product, other commercial real estate assets will be insulated from widespread distress,” Evans adds. “There is always investor demand to buy multifamily, retail, and especially industrial, particularly at a discount.”

Rates & Pricing Expectations

Expect interest rates to be lower by the third quarter, settling in the 5.5% to 6.0% range and holding steady for 24 months after that, according to Quinn. Putnam maintains that expectations for lower rates will support a hold mentality by investors as values will recover with even the most modest cuts by the Fed. Overall transaction volume will pick up from 2023 lows, but not bounce back to the high levels seen in 2021 and 2022.

Pricing uncertainty will “dissolve” during the last half of the year after interest rate stabilization, Quinn says. Yet, Putnam expects the policy uncertainty of the election cycle to add to the pricing unpredictability.

Portfolio Deal Outlook

Portfolio deals will become more prevalent, but not like during the Great Financial Crisis, says Putnam.

“Portfolio transactions will only come back in Los Angeles if they are in some form of distress, if they’re in special-service receivership or foreclosure, which is a mechanism of the passing of measure ULA, the additional transfer tax on property sales above $5 and $10 million,” Evans says.

Putnam expects there to be “tactical transactions for reallocation purposes,” but limited wholesale deals to mostly B and C product. He adds, “Some investors will shed office product that has become non-durable, but apartments, industrial, and retail will be held.”

Source: “Will CRE Portfolio Deals Return in 2024?“

Rental prices for office space in Israel plunged by 16 percent last year, as tech firms — global and local — have been downsizing and driving up the supply of commercial property, according to a report by commercial real estate consulting firm Cushman and Wakefield Inter Israel.

The data shows that the average price per square meter in the nation’s main business districts dropped to NIS 114 ($30.45) in 2023 from NIS 136 ($36.33) in 2022.

“The office rental market is a direct reflection of what is happening in the economy and in the Israeli tech sector, which is so dominant in Israel,” said Yoram Blumenthal, the managing partner of Cushman and Wakefield Inter Israel, in an interview from the firm’s offices in Ramat Gan.

“In a way, you could say it is the pulse of how the economy is doing,” he added.

The price per square meter last year was still higher than the low of NIS 98 per square meter registered in 2020, amid the lockdowns triggered by the coronavirus pandemic that led to widespread virtual work practices. Prices started to rise again in 2021, to NIS 107 per square meter, and reached a high in 2022, as firms called workers back to the office. That year was also characterized by a technology boom that saw Israeli startups raise an unprecedented amount of money in investments and create a record number of tech unicorns.

Prices for office space surged in these boom years, with developers initiating new and ever more luxurious projects for their clients, propelled by the lowest-ever interest rates and sky-high demand. Then, suddenly, last year, it all came crashing down — much like the Israeli tech market, which saw investments plunge 56% to $6.7 billion in 2023 compared to the previous year, according to IVC Research Center which tracks the industry.

The slowdown of the global tech industry toward the end of 2022, the judicial overhaul in Israel proposed by the government of Benjamin Netanyahu, and the rise in interest rates globally, all contributed to the drop in prices in 2023, said Blumenthal.

He added that it was still too early to assess the impact on the market of the first three months of the Israel-Hamas war, triggered by the terror group’s shock October 7 massacre in southern Israel in which some 1,200 were killed and 253 taken hostage to Gaza. The Bank of Israel has lowered its growth forecast for the 2024 economy to 2% from a previous forecast of 3%, and in January cut its borrowing costs for the first time since April 2020 to help support households and businesses as the war continues.

The 16% decline in average office space prices is the steepest Blumenthal has seen since the pandemic lockdowns, he said. Rental prices declined 8.4% between 2019 and 2020, the Cushman and Wakefield Inter Israel data shows.

“Demand for office space has frozen,” he said. If the economic crisis continues because of a prolonged war which may expand to other fronts, the glut of office space that is expected to come onto the market in 2026 and 2027 – from construction started in the years of record low interest rates and the tech boom – could create a further supply and demand imbalance in city centers, he warned.

Falling demand

The drop in the value of office buildings is a global phenomenon, triggered by the pandemic-era shift to remote work environments in which office attendance has stabilized at 30% below pre-pandemic levels, according to a July report by consultants McKinsey.

This shift is likely to erase some $800 billion from the value of office buildings in key global cities by 2030, the report said. The lower office attendance is more prevalent in the knowledge economy such as the professional services, information and finance industries, in which workers can easily work virtually. This will put the vibrancy of the cities, including New York and San Francisco, “at risk.” Falling demand will result in surplus office space, particularly in lower quality and older buildings, the report said.

The McKinsey report said that cities and buildings can adapt to the new reality by taking a “hybrid” approach as well – making sure to develop mixed-use neighborhoods, constructing more adaptable buildings, and designing multi-use office and retail spaces.

According to the Cushman and Wakefield Inter Israel data, Menachem Begin and Yigal Alon streets registered the greatest average drops per square meters in Tel Aviv, with prices declining in other business-centric cities as well including Herzliya, Rosh Ha’ayin and Kfar Saba.

The decline in demand for office space has not so much been triggered by the remote working trend, said Blumenthal, but by lower economic activity.

“Israelis like coming to the office because they prefer social settings and teamwork, which is a key factor for success,” he said.

The lower rental prices could mean that developers will find it harder to finance and set up new projects, Blumenthal said. When added to a war-triggered lack of construction workers, this could mean that in the future we could see a delay and decline in the supply of office space, which would rebalance the market.

This delay could help developers meet a “more positive” economic cycle later on, he said. “Also, the dramatic decision of the Bank of Israel… to reduce the interest rate by 0.25% in combination with other global economic factors may signal the beginning of a reversal of the trend.”

The recent outstanding economic performance of the global tech giants is also an indication of a positive turnaround of economies and eventually of Israel’s office scene as well, he said, as Israel is home to R&D centers of most of the global tech giants.

Source: “Economic downturn, tech slump send commercial real estate prices tumbling”