Rise in Distressed Sales Signals New Chapter for Beleaguered Office Market
Uptick in troubled office-building sales indicates more owners believe weak demand is here to stay
Property owners are starting to unload troubled office buildings at fire-sale prices, a sign that the office market slump is moving into a new phase where more landlords are ready to capitulate.
In recent weeks, Blackstone sold the Griffin Towers office complex in Santa Ana for $82 million, or about 36% less than the firm paid in 2014, say people familiar with the matter. Principal Financial Group sold a Parsippany, N.J., office building for $14.3 million, down from the $52 million it paid in 2008, according to participants in the sale.
The tower at 350 California in San Francisco, valued at $300 million in 2019, is expected to trade at about $60 million, or roughly 80% below that previous valuation.
Office building values have steadily declined during the pandemic as shifting workplace strategies reduced demand for space and vacancies rose. Higher interest rates have also hammered the sector, making it much more difficult for landlords to refinance a property or fund the building improvements and amenities needed to attract tenants.
Still, up until recently, the office sales market has been moribund. Investors purchased only $10.7 billion worth of office property in the first quarter of this year, down 68% from the same period last year, according to data provider MSCI Real Assets.
The lack of activity is common in the early stages of real-estate market downturns because owners try to extend their loans or find other solutions, rather than dump their properties at a big loss. During the global financial crisis, many owners negotiated mortgage extensions with creditors on the assumption that office markets would rebound when the economy started expanding.
Now, the uptick in troubled office-building sales indicates that more owners believe that weak demand is here to stay. The volume of distressed office deals is expected to rise even further in the months to come, as billions of dollars worth of mortgages need to be refinanced.
Listings of office buildings for sale are also rising. “Office inventory is growing,” said Steven Jacobs, president of Ten-X, one of the biggest auctioneers of commercial property online. “Investors want out.”
Sales at marked-down prices likely will put more downward pressure on the office market, not only by establishing lower prices for comparisons but by undercutting their competitors’ rents, market participants say.
For example, a buyer who pays far less than replacement cost for a building in a market where neighbors charge $25 a square foot, will be able to rent space at $15 a square foot, said Mr. Jacobs.
“They’re going to annihilate those other buildings,” he said.
Ten-X listed 91 office properties in the first quarter, up 44% from the first quarter in 2022. The second quarter of this year is on track for similar growth, Mr. Jacobs said. In the first week in May, Ten-X held 11 successful auctions of office properties.
Most of those traded at sharp discounts. On average, the sellers met the market at prices that were about 31% below their initial expectations, Mr. Jacobs said. During the same period one year ago, office sellers accepted an average 7.1% discount, he said.
The delinquency rate of office loans that were converted into commercial mortgage-backed securities increased to 2.77% in April, the highest rate since August 2019, according to data firm Trepp. In the first quarter of this year, 26 office buildings were taken over by creditors in foreclosure actions, compared with six in the first quarter of 2022, according to MSCI.
Some buyers are finding the discount pricing too good to resist. In Chicago, the investment firm of the family that owns Jose Cuervo tequila is in advanced talks to buy 300 South Wacker Drive for about $100 million, a 38% discount from 2017, according to people familiar with the matter.
Jose Perez, a managing director of the firm, Agave Holdings, declined to comment on any specific deal. But, in general, he said Agave is looking at discounted office deals throughout the country.
“We have learned from the past, that when everyone is selling, buy; and when everyone is buying, sell,” he said.
Earlier this spring, global investment manager Hines paid $60 million for a new office tower in Washington, D.C., less than half of what it cost to develop, according to Alfonso Munk, the firm’s chief investment officer, Americas.
By paying that price, Hines was able to invest enough in interior work and building amenities to sign the law firm Davis Polk as a tenant for more than half of the 11-story building.
“That suffering we’re seeing across financial markets is creating an opportunity,” Mr. Munk said.