Over the past 15 years or so, I’ve been involved in distressed debt and asset management of commercial real estate nationally and watched the financial, political, and real estate markets through this lens. By observing patterns, trends, and industry developments, I have formed a few insights into challenges and opportunities that may lie ahead during the next 18 months.
The current debt markets are very conservative and all but frozen. Values are down; cap rates are up; and billions in refinances are due in the next year and a half. The cost of capital and equity needed to refinance might not make sense at current debt levels. Inflation is still strapping the economy and not likely to move during a pre-election year. With very little value creation available in the current market and the factors outlined above, a “reset” of market value is inevitable.
The office sector has been hit hard by the unexpected impacts of remote work after the pandemic, and Class B has seen the most drastic decline. Why? Workers’ wants and needs are shifting. As offices age, the cost to complete upgrades, compete with concessions, as well as the overall need for space, makes Class B the last pick in most markets. Class A rent is also declining. With interest rates high, demand and values low, and time needed to stabilize the markets, I expect much of Class B will be foreclosed or sold for discounts. I also think that in the next three to five years, office will be repurposed, just as retail was during The Great Recession.
But not every office-focused market is headed for dramatic change. In some instances, core office markets will likely remain office markets. For example, in New York’s Manhattan district, a new tax incentive program passed for owners of older office buildings built prior to 2000 and over 250,000 square feet makes it likely the neighborhood will continue to operate primarily as an office-focused market. In areas like this, owners can take advantage of incentives for renovation.
So, if you are an owner of Class B, look at your options—all of them. I’ve seen a lot of owners hold on to real estate when they shouldn’t. Be honest with your partners and yourself, and don’t recapitalize an asset that needs to be “reset” unless you have no other choice.
As brokers, reputation matters. If you are listing an asset, make sure you know your owners’ objectives, but also be certain of what they can or cannot commit to. Lender approval for leases is required in a distressed situation, and it’s worth keeping in mind that you might not know your owner is in distress. Conversely, if you are representing a tenant, make sure the owner has the tenant improvements to execute a lease commitment.
Tanya Hart Little is the founder and managing partner of Hart Commercial, where she leads planning, operations, franchise, and corporate services accounts. She is a leading authority in commercial real estate, known for her work in strategic asset management.
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