Analysis: US office market shows signs of bottoming after big discount sales

Newmark

03/10/2024 11:00

* 
      Prices for office buildings fell 12.4% year-over-year as
of Q2
    

        * 
      Sales of stressed properties at big discounts set new
pricing
benchmarks
    

        * 
      Federal Reserve's rate cuts may not be enough to revive
market
    

  
    By Matt Tracy and Shankar Ramakrishnan
       Oct 3 (Reuters) - The beleaguered U.S. office property
market may be bottoming out, analysts told Reuters, pointing to
a string of sales of stressed properties at big discounts over
the last quarter that have helped set a new pricing benchmark.
    The U.S. office property market has been hard hit since the
pandemic by higher interest rates and as many office workers
worked from home. Prices for office buildings have fallen 12.4%
year-over-year as of the second quarter, according to the RCA
Commercial Property Price Index, causing speculation about when
a bottom in the market would be reached.
    "Peak distress is fully behind us," said Stephen Buschbom,
research director at industry research firm Trepp, who added
that what was now key is to have more deals struck to give the
industry an idea on price. 
    "We still have price discovery left," Buschbom said. "An
increase in transaction volume will mean that’s becoming more
palatable for those holders."
    Throughout 2023 and the start of 2024, many developers and
lenders chose to extend maturing loans with new terms or held
off a sale to avoid recording a big loss. 
Office sales averaged $35 billion per quarter pre-COVID-19 but
as property valuations dipped on continued vacancies and high
operating costs, they have averaged only $13.4 billion per
quarter since 2023, according to data from MSCI Real Capital
Analytics. 
However, some analysts have seen signs of a pickup in sales of
stressed properties, which has led some to think there is a
turning point in the market. 
"There are growing signs of market-bottom capitulation or
sophisticated property owners selling their properties even at
large discounts to their purchase price which is helping create
some sort of pricing benchmark for office values," said Kevin
Fagan, Moody's head of Commercial Real Estate Economic Analysis.
    Since the end of the first quarter in the U.S., there were
seven office properties sold at a discount of more than $100
million compared to just one in the first quarter and just two
in the whole of 2023, Moody's said in an August report which was
based on public records data. 
    The list of sales included a Midtown Manhattan office
building - 135 West 50th Street - that sold for a 97% discount
to its original price of $285 million for a $276.5 million loss,
according to Moody's, which also listed office sales in Chicago,
Seattle and Washington, D.C. 
Another example Moody's listed is 1740 Broadway, which sold at a
$416 million loss compared to its previous purchase price.
Investors made losses on AAA-rated bonds sold against it, for
the first time since 2008.
Yellowstone Real Estate Investments, which bought 1740 Broadway,
did not return a request for comment. UBS, which sold the 135
West 50th Street loan, and JLL, which brokered the sale of both
properties, declined to comment.
     
    LOWER RATES BOOST 
    With a lack of a pricing benchmark, property owners have
been reluctant to sell because lower transaction volumes created
a mismatch in pricing expectations. They have instead chosen to
extend or refinance existing loans to tide over to a period when
interest rates are being cut and improve their ability to retain
these properties. 
    The real estate industry has suffered from a double whammy
of low vacancies and revenues, which have made it difficult for
property owners to make interest payments on existing loans. 
    Even with rate cuts, borrowers with nearly 72% of some $19
billion of maturing loans over the next 12 months, could
struggle to refinance because they may need to come up with an
average 30-35% of equity to get a takeout loan, said the Moody's
study. 
    "There will be some large balances (in the general market)
towards the end of this year and into early next year that go
through a sales transaction," said Ryan Reiss, chief lending
officer at D.C. regional lender EagleBank.
    The Federal Reserve recently reversed the direction of U.S.
interest rates for the first time since 2022 with a 50 basis
point cut in September and promised more.
    But while the 50 basis point cut could show "light at the
end of a very long tunnel" the "(commercial real estate) market
revival would need at least 300-400 basis points in interest
rate cuts to compensate for the sharp decline in property
valuations," said Alex Horn, founder of private lender
Bridgeinvest.
    One recent example of a lender pushing forward was Parkview
Financial which offered to sell $300 million of seven
multifamily and office loans - a mix of performing and some in
litigation - in New York, New Jersey and Connecticut in an
auction, according to Parkview CEO Paul Rahimian and a
confidential offering memorandum seen by Reuters.
    Rahimian said his firm received multiple bids at 95-98 cents
to the dollar for four of those loans, which it plans to close
over the next six weeks. Three loans were on hold, he said. The
firm plans to use the proceeds from the sales to hand out new
loans, Rahimian said. 
    Such sales were creating opportunities, said Keerthi
Raghavan, head of ABS strategy at Waterfall Asset Management,
which has invested nearly $2 billion over the last year in bonds
and loans sold at steep discounts.
    "Fundamental issues are not something that will disappear
overnight in our view with front-end rates being lower, and
there (are) still plenty of CRE assets sitting on balance sheets
that need to be sold or resolved, which should keep supply
elevated," he said.

 (Reporting by Matt Tracy and Shankar Ramakrishnan; editing by
Megan Davies)
 ((mailto:Matt.Tracy@thomsonreuters.com;
Shankar.Ramakrishnan@thomsonreuters.com))