Why office buildings are still struggling

With the pandemic receding, kids returning to school and companies telling employees to get back to the office, companies that own large office buildings were hoping to get through this fall after two nightmarish years.

Instead, things got worse.

More office workers are back at their desks than a year ago, but office building footfall in New York, Boston, Atlanta, San Francisco and other cities languishes well below pre-pandemic levels. As leases come to an end, companies often opt for smaller offices, leaving landlords with millions of square feet of vacant space. And more space is expected to hit the market in the coming months as companies like Meta, Salesforce and Lyft lay off workers. More than 100,000 tech workers have lost their jobs this year, according to Layoffs.fyi, a site that tracks job cuts.

Rising interest rates are also weighing on the industry. Many owners are no longer willing or able to acquire and improve older buildings or construct new ones. Seeing little benefit in keeping buildings with low occupancy and paying interest on mortgages, some landlords simply sell properties to lenders. Others seek to convert office buildings into residential complexes, although this can be costly and take years.

Investors on Wall Street seem to think the office space sector is on the verge of collapse. Shares of large owners and developers are trading near or below their pandemic lows, underperforming the stock market as a whole by a huge margin. Some bonds backed by office loans are showing signs of strain.

The value of office buildings in the United States could plunge by 39%, or $454 billion, in the coming years, according to a recent study by business professors from Columbia and New York University.

“We’re seeing a lot of tenants not renewing their leases, moving away altogether, or renewing their leases but signing up for less space,” said Stijn Van Nieuwerburgh, one of the paper’s authors and a professor specializing in real estate in Columbia. Business school. “It all adds up.”

A sickly office sector can hamper the recovery of cities that depend on the jobs and tax revenue that commercial buildings provide. For example, New York City collected about $6.8 billion in property tax revenue from office towers in the fiscal year that ended in June, or about 9% of its total tax revenue. compared to $7.5 billion the previous year. The market value of office buildings in the city fell $28.6 billion last year, the first such decline since at least 2000, the state comptroller’s office estimated.

A sign of the speed with which the market has fallen back in some places, companies are giving up space they had only rented a few months earlier. Meta, Facebook’s parent company, recently decided to sublet all of the space it signed up about 10 months earlier in an office tower in Austin, Texas called Sixth and Guadalupe. Meta still has to pay rent on 589,000 square feet, but its decision to find someone else to occupy the space could drive down rents in Austin, which until recently was considered a thriving and growing tech hub. full growth.

The struggle to fill empty offices is a national phenomenon.

The amount of office space rented in the United States in the three months ending in September was nearly a third below the quarterly average for 2018 and 2019, according to Avison Young, a commercial real estate services firm. .

According to Jones Lang LaSalle, a commercial real estate services firm, office vacancy rates across the country are at a record 19.1%, with Chicago, Houston and San Francisco exceeding 20%. This includes the record 185 million square feet, or 3.85% of the total office space in the country, which is available for subletting. According to Jones Lang LaSalle, an additional 104 million square feet of office space will hit the market through 2024 as new buildings are completed.

In some ways, New York, the nation’s largest office market, with 540 million square feet of space, is particularly vulnerable. The city’s old office buildings are losing their best tenants to well-equipped new buildings in neighborhoods like Hudson Yards on Manhattan’s Far West Side, leaving many offices empty in downtown and downtown.

“Downtown availability is at an all-time high of 20.2%,” said Franklin Wallach, executive managing director of brokerage firm Colliers. “These are older buildings in the canyons of Wall Street, and we’re seeing big vacancies, not from a single tenant but from tenant migrations all hitting at once.”

Office landlords weathered the pandemic in good health, as corporate tenants with long-term leases continued to pay rent even if their employees weren’t coming into the office.

But owners, who generally display sunny optimism even on gloomy days, now seem more cautious. They recognize, somewhat reluctantly, that many of their corporate tenants are sticking to some form of work-from-home policy, and their optimism is mostly focused on a small part of the market – new buildings.

Still, they believe demand for office space will eventually return. William C. Rudin, chief executive of Rudin Management, a New York developer and landlord, said that in past recessions companies have given back space. But when the economy improved, business leaders often changed their minds and said, “Oh, my God, we don’t have enough space. Need to take up more space. »

The work-from-home revolution is not limited to New York and San Francisco. Even in Texas, office traffic is much lower than it was before the pandemic. Weekly occupancy is 62% of pre-pandemic levels in Austin, 57% in Houston and 53% in Dallas, according to data from Kastle Systems, a security card reading company.

Many landlords claim that Kastle’s data does not reflect footfall in their buildings. Kastle reports weekly attendance in the New York metro area is just under 50% of pre-pandemic levels, but Rudin said his towers average about 65% full over the course of a week. He said occupancy was much higher in buildings with space leased by financial services companies, many of which forced employees to return.

Office owners borrow from banks and credit markets to acquire and build their buildings. So far, most of them are repaying their debts, according to data from Trepp. But signs of strain are emerging on commercial mortgage-backed securities. These bonds are backed by payments on office loans and then sliced ​​into layers, with the top layer being better protected against default than those at the bottom.

“I think there’s more trouble ahead,” said Gunter Seeger, portfolio manager at Pinebridge Investments, which invests in debt used to finance office buildings. “It’s happening in slow motion – you see it coming, but it’s not happening fast. We’re limping.

Investors, for example, are eyeing bonds that are secured in part by lease payments from tenants of 300 North LaSalle, a Chicago building owned by the Irvine Company. Boston Consulting Group and Kirkland & Ellis, a law firm, occupy just over 60% of the imposing building, and the two are expected to leave in a few years. The price of one of the bonds, which carries an average rating – neither top nor bottom tier – has fallen 22% so far this year, implying a yield of around 17%.

Representatives for the Irvine Company and Kirkland & Ellis declined to comment. Boston Consulting Group did not respond to requests for comment.

Williams & Connolly, a law firm, this year moved its headquarters from a building in downtown Washington to a new development at the Wharf. Hines, the owner of the old building, who had a 10-year loan of $135 million, signed an agreement this fall with his lender, Allianz Real Estate, to sell the building.

A spokeswoman for Allianz declined to comment.

An executive from Hines, a private real estate investment firm, said he had owned the building for more than 30 years and it was a profitable long-term investment. “We continue to operate the building and are working with the lender to sell the property to a third party,” Hines senior managing director Chuck Watters said in a statement.

Landlords are also finding that some of their major tenants settle for much less space when moving into new offices.

In August, KPMG signed a 20-year deal to move its headquarters to Two Manhattan West, a high-rise slated to open next year bordering Hudson Yards. KPMG, which has adopted a hybrid working model, is leaving three older buildings in Midtown and reducing the total space it rents by 40%.

“For our business, we believe that a hybrid future – a mix of fully remote, hybrid and onsite teams – will deepen the connections between current and potential employees and leaders, giving us a competitive advantage in the marketplace,” said said W. Scott Horne. , a KPMG spokesperson.

Mr. Rudin, whose company owns two of the buildings KPMG is moving from, said: “We have a very good retention rate in our portfolio, but we also know that things change and requirements change. He added that his company was improving its old buildings and successfully renting them out.

Companies can find it difficult to drastically reduce their office space if most employees have to come in, say, three days a week. But analysts say that over time, managers will become more adept at minimizing space. And executives could seek to cut costs by cutting office space even further if the economy slows sharply or slips into a recession.

Columbia professor Van Nieuwerburgh calculates that offices in New York cost an average of about $16,000 a year per employee. “It’s real money,” he said, “and companies will try to save it.”

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