Office Values are Dropping, So Where Are All the Distressed Sales?

May 14, 2024 Don Catalano Don Catalano

Office property values are dropping. Obvious and true, but just by how much are they dropping?


To begin the search for an answer, a logical place to start is the difference in sale price for properties now against past values. So, according to Morgan Stanley Capital International (MSCI), the average price per square foot on office sales occurring during the third quarter of 2023 dropped 11.1 percent to an average of $220 per square foot. 


By the third quarter of 2023, office sales totaled $36.6 billion, reflecting a 62 percent decrease compared to the year before.


The $10.6 billion in office sales during the third quarter represented the lowest volume since the first quarter of 2010.


But there’s a lot going on under the surface of property sales. As is well-known now, many office landlords can’t maintain occupancy rates and have been forced to go into default.


In some cases, but not all, the owner or receiver sells the property to mitigate losses. And in many of those cases, the building is sold for far less than what it was originally listed. It is happening, but many now claim that the fire sales of office properties have only begun.


Delicate financial moves by receivers or banks are putting off the hurt – and disguising the rate at which office property values are dropping.


So, to understand the full picture on declining office values, let’s take a look some recent fire sales, and explore underneath the surface to discover what's preventing and prolonging hundreds more similar sales.


Surviving The Office Apocalypse

Office Fire Sales in San Francisco

Fire sales are happening, and most of them just happen to be on the same street…


It’s no secret that San Francisco’s office market is decimated, especially as most big-tech firms, which have historically grounded the market, have either slashed their footprints and/or workforces. 


The city is boasting numbers that rank it the worst performing in the country. Vacancy rates are currently up to 35%. However, with the current occupancy rate below 50%, it doesn't take a genius to see that vacancy rates will catch up, hitting the 50% mark. This is a catastrophic level of vacancy. 


The demand for new office space is dismal, and because of this, we are seeing the most concentrated office sales in the country, listed for a fraction of a fraction of what they would’ve cost in the Silicon Valley Gold Rush.


Investors hopeful that the market will eventually even out (or maybe the sale is so good they don’t even care) are picking up towers in ex-premium locations for cents on the dollar.


A Market Street tower spanning 90,000 square feet was acquired for nearly 90% less than its previous trade. Initially purchased for $62 million in 2016, it was sold for approximately $6.56 million, translating to about $72 per square foot.


market street SF


Adjacent to the above sale, another sale took place at 350 California Street in Downtown San Francisco. Originally listed for $250 million in 2020, the 286,000-square-foot tower was sold to San Francisco-based developer SKS and The Swig Company for an estimated $60 million. That's a whopping 76% discount. 


Another distressed sale occurred on the same street, where Hudson Pacific Properties acquired its partner's 45% share of a Market Street office tower at an 80% discount from the purchase price. The partner initially bought the 45% share of 1455 Market for $219 million and sold it back for $44 million.


So, all of these sales must be jacking up the percentage of sales on distressed buildings, right? Wrong!


Extend and Pretend Office Buildings Aren't Underwater

According to MSCI Real Assets,only 3.5% of all office deals in the U.S. involved a distressed seller in 2023.


This seems like quite a small number, especially against a backdrop of rapidly dwindling vacancy rates, one might assume they’d be everywhere.


cre recession red flag


And if you look at the average drop in value, it substantiates that assumption.


The average price per square foot on office sales in San Francisco occurring during the third quarter of 2023 dropped 40% to average $448 per square foot. Another major city, Manhattan suffered a similar fate, where prices declined 24% to an average $549 square foot.


So why are sales of distressed properties still relatively rare? Well for one thing, some are holding off for office demand and/or other economic conditions to stabilize.


“Some borrowers and their lenders are likely holding out for lower interest rates: Cheaper debt might limit the price cuts they need to accept when they sell.”

-Wall Street Journal


On the other hand, the other phenomenon at play is the extend and pretend.


Across the board, lenders are extending the maturity dates of office loans or modifying the terms, such as reducing interest rates or temporarily lowering payments, to help borrowers avoid default or foreclosure in the short term.


This approach may give borrowers additional time to improve their financial situation or wait for market conditions to become more favorable, hence "pretending" that the underlying issues will resolve themselves. However, it can also prolong the resolution of financial problems and potentially lead to larger losses for lenders if the underlying issues persist or worsen over time.


And this is exactly why we are seeing the putting off of further fire sales.


“Lenders are also eager to kick the can down the road. They don’t want to force borrowers to sell buildings into a weak commercial real-estate market, which would lead to punishing losses."

-Wall Street Journal


And with another wall of maturities about to slam the market, there’s only so much extending and pretending that can happen before we get hit by a hard reality check. Read more about extend and pretend. 


Hope in Other Markets

The other point to mention is that looking at San Francisco’s states, as dramatic as they are, don’t give an accurate picture of the national office market. While there were observed drops in major cities, especially in New York and California, there’s hope in the Southern market. The rebirth of office demand across the Sunbelt has caused steadily climbing averages in the price of office sales.


In Houston, office property prices increased 7.7 percent to average $194 per square foot. Cincinnati, saw prices climb 4.7 percent to $130 per square foot. And to ring in three top three, Nashville office properties rose 4.1 percent to $328 per square foot.




But regardless of the hope in the South, there are $1.5 trillion of US commercial real estate debt comes due before the end of 2025, according to Bloomberg


And it is inevitable that more fire sales are on the horizon for properties that can’t keep up with their debt. So, with this in mind, how can corporate tenants prepare themselves for this new era in office leasing?


Safeguards for Tenants

For one, check any prospective landlord’s financials before signing a new multi-year lease. The more stable ground they’re standing on, the less likely it will be for you to have to deal with the possibility of the building exchanging hands or a receiver stepping in. Because it that happens, you most assuredly will face a drop in services or will have to pick up the bill to mitigate the situation.


And if your lease is inherited by a new building owner, while they’re unlikely to kick existing tenants out, to truly avoid this possibility you need to outline your rights to the property in the original lease. A SNDA ensures that your lease will stay intact in the event of a new owner.


And truthfully, these tips are only the tip of the iceberg. We are in uncharted territory and as the full situation evolves in the next few years, one thing is certain: Tenants need to conduct more due diligence than ever before to make sure they don’t get caught in the crossfire of a defaulting landlord, bank, or new owner.


So, safeguard yourself with the tenant’s essential guide to navigating a post-pandemic office market marked by a minefield of defaulting landlords. Surviving the Office Apocalypse is written for corporate tenants by True Tenant Reps™ to arm them with the information they need to come out on top in such a polarizing market. Get your free copy today!


Surviving The Office Apocalypse

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