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How Investors are Reacting to the Evolving Office Sector

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In the current office landscape redefined by hybrid work and other cultural shifts and economic factors, we’re also seeing the impact of vacancies on office valuations. Transaction volume is down 60% year-over-year and price per square foot is down ~25% year-over-year. CommercialEdge reports that in the next three years, 9,500 buildings, or about 17% of all office stock, will be up for renewal. The amount of space with loans maturing over the next three years will hold at about 380 million square feet.

Maturing loans are coming into focus as a trend to watch in the office sector, including which markets will be hit hardest. “The distribution of the properties with maturing loans also isn’t even, meaning there will be pockets of areas hit much harder. Atlanta, Denver and Portland, Oregon all have more than 10% of their stock maturing. Chicago and Los Angeles each will see about 7% of their stock mature. Over the next three years, eight of the top 25 markets will see at least 20% of stock subject to a maturing loan, led by Atlanta (29.1% maturing by the end of 2025), followed by Portland (27.5%), Denver (24.3%), Chicago (23.0%), Los Angeles (21.5%), Washington, D.C. (20.4%), Austin (20.0%) and Dallas-Fort Worth (20.0%). Some of these markets also have vacancy rates above the national average – with Atlanta sitting at 20.5%, Chicago 19.2% and Denver 17.6% - which will add more uncertainty for owners.” (Source: CommercialEdge)

In his analysis of current trends and CommercialEdge data, Paul Fiorilla, director of research at Yardi, noted that “conditions are ripe for a spike in commercial mortgage delinquencies. Rising interest rates have pushed loan coupons significantly higher, lenders are cutting back to varying degrees and property fundamentals are weakening amid slowing economic growth and consensus recession forecasts.”

Watching market trends, along with having fast access to reliable data around those trends, is helping investors in a quickly changing market identify alternative opportunities for their money – including office to multifamily conversions.

"Office-to-residential conversions are becoming increasingly popular as housing remains in short supply and many office buildings sit vacant. However, these conversions come with many challenges, including location, configuration and cost. For such projects to become more than a niche opportunity, government incentives are needed to make them viable. California has allocated $400 million in grants for conversions, while Baltimore has reauthorized a tax credit to incentivize conversions. While it can be expensive to provide incentives, doing nothing could be even costlier for local governments that rely on property taxes on commercial real estate." (Source: CommercialEdge National Office Report, May 2023).

Knowing asset details including age, prior renovations, location, LEED certification and green building potential, is key to making a smart investment decision. However, seeing all the components that drive asset value can be a challenge. In a May 2023 PERE Keynote Interview, Chris Barbier, senior director of investment management at Yardi, stated that investors demand transparency as owners and operators deal with increasing amounts of data. When asked how technology can assist in understanding ROI, Barbier said, “There’s a reduced footprint coming for a lot of organizations. The benefit from the investment side is that you can be part of a property that doesn’t have just one asset type. By having information about the assets, investors are able to reduce their risk and exposure to asset obsolescence.”

Barbier also stated in the PERE interview, “Transparency around the transformation of buildings and how they’re being operated is becoming more imperative… Return on investment is the ultimate goal. The question to answer is: what efficiencies are driving that? For instance, how are your marketing dollars being spent? Are you getting the most leads that are then driving rentals on the multifamily side or new leases on the commercial side?”

Faced with these market realities, how are investors reacting? Investment technology, including portals that provide information across asset classes, is providing investors quick access to their investment positions with drilldown into asset operational data along with details about new investment opportunities to keep them informed, confident and nimble.

When inquiring about both current and potential investments, investors want to hear “I’ll send you that information today” instead of “I’ll get back to you next week.” Real estate and investment management platforms connected with investor portals deliver the following benefits to investors and owners:

• Self-service access to key investment information
• Communication tools to request more detailed property-level information
• Information and data on new investment opportunities
• Accounting software integration so owners can easily and quickly provide information to investors, including operational components that could impact debt covenants and related information

No matter what is happening in the office market and in our current fast-changing industry, accurate data delivered quickly is driving both portfolio performance and the best decisions for owners, operators and investors. For further insights, read the CommercialEdge Market Bulletin: With Distress on the Rise, How Worried Should We Be?

Turner Levison, Industry Principal, Yardi Turner Levison is focused on helping CRE occupiers leverage solutions from the Yardi Corom suite. He was the CEO and co-founder of CommissionTrac, a deal flow and commission management platform for CRE brokerages, which was acquired by Yardi in 2020.

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