The national office market has been on a bumpy ride since the Covid-19 pandemic, and additional challenges are lurking on the horizon.
A recent analysis by CoStar Group Inc. (Nasdaq: CSGP) found 55% of office leases signed before the pandemic that were active in January 2020 have yet to expire, meaning there’s still a lot of potential vacancy or space reductions that could hit the market.
“All of the pain we’ve been seeing in the office market, we’re realistically only halfway through and are still seeing that aftershock,” said Joseph Biasi, head of capital markets research at CoStar Risk Analytics.
Although some companies inked short-term renewals on their leases at the height of the pandemic, uncertain about what the future would bring, renewal volume today is about half of what it was between 2016 and 2019, CoStar found. The firm also found new leasing activity has decreased 12.5% since the pandemic.
Other groups that track office-space demand are also finding weaker space demand, with VTS Inc.’s Office Demand Index, or VODI, finding office space demand in major U.S. markets in the second quarter at 53% of its average level in 2018-19.
All of this adds up to mounting concern in the office world, especially as trillions in loans backing commercial real estate properties — including beleaguered office buildings — will come due in the coming quarters and years.
Federal regulators issued guidance in late June that encouraged lenders to be flexible and work “constructively” with commercial real estate borrowers facing financial challenges. The guidance is modeled on a statement issued by regulators in 2009, during the global financial crisis, when commercial real estate also faced significant losses.
But, Biasi said, loan workouts make the most sense if a building can realistically perform down the line. With office values declining, occupancy declining and much higher interest rates — not to mention return-to-office metrics flattening across most major markets in 2023 — a lot of landlords are facing a difficult situation at refinancing.
Nationally, CoStar is tracking 261.6 million square feet of available sublease space, compared to 144 million square feet in the second quarter of 2009, the peak during the global financial crisis. Sublease space is an indicator of future vacancy and potential risk, something CoStar has been encouraging lenders to track as they work to understand risks around the corner in their portfolios, Biasi said.
“We expect, at least through 2023, the vast majority of (commercial mortgage-backed securities) loans that have office exposure are going to have some trouble at refinancing,” he said. “Extend and pretend is difficult when you have values declining, (net operating income) struggling as well, vacancy increasing … we expect it to be a long-term issue.”
Refinance rates for CMBS loans were 78.1% and 71.8% in the first and second quarter of this year, respectively, compared to 85.5% in 2019, Moody’s Investors Services recently found.
For landlords and companies dealing with a glut of office space, some are coming up with new solutions in an effort to boost occupancy and potentially attract tenants to their buildings.
New York-based Convene, which describes itself as a hospitality company and provides meeting, events and coworking space, found through an analysis of its clients a majority are using Convene-branded spaces to supplement or partially replace traditional office space.
Right now, because they’re trying to woo a more shallow tenant pool, landlords are willing to invest significantly into amenities and common spaces, said Brian Holland, head of real estate at Convene.
“We’re getting more calls than we ever have, and landlords are desperate to differentiate themselves,” he continued. “The dynamics of the conversation (have) completely changed.”
He said the company is also hearing more frequently from tenants themselves, many of whom have excess space on their hands. Earlier this year, Convene opened Quorum by Convene, a 40,000-square-foot venue that’s part of law firm White & Case LLP’s headquarters in Midtown Manhattan but managed by Convene. While White & Case has preferential rights to use it for meetings and events, the space is rented out to other groups when not used by the firm.
Conversions of vacant office buildings into new uses, especially residential, are also a hot topic right now but aren’t expected by most experts to be the silver-bullet solution to fixing the glut of office space hitting the market.
Landlords are having to give extra concessions at renewal time or are employing other tactics at the negotiating table to retain and attract tenants, many of whom are scrutinizing landlords more heavily because of mounting risks facing office-building owners.