At this time last year, it was extremely difficult to establish the market value of any commercial property, including industrial and multifamily assets that have subsequently weathered the COVID-19 health crisis quite well. Today, according to appraisal experts, most asset types can be accurately valued. But there is an exception — office buildings.
Office assets have a cloudy future, making it especially difficult to establish values more than a year after COVID-19 emerged. The longer-term fortunes of the hard-hit retail and hotel sectors are more predictable due to the performance of individual assets prior to the pandemic. For example, grocery store-anchored retail properties were doing well pre-pandemic, whereas dated suburban malls were struggling against the rising competition from online shopping platforms. These trends are expected to continue. Meanwhile, hotels were the sector hardest hit by the pandemic but are expected to bounce back quickly due to a surge in vacation travel — and an uptick in business travel and conventions — when COVID-19 is fully under control.
Office space, however, is more of a puzzle because many people continue working from home, which is an unexpected shock for the sector. The basic problem is that nobody knows for certain what percentage of workers will return to the office, or how this will affect occupancy levels and rents. Ultimately, a decline in office rents would cause asset values to drop.
“Office is by far the most challenging to value of the four core property types,” says Eric Enloe, managing director of JLL’s valuation and advisory services platform. Enloe notes, however, that the office sector is highly nuanced, and the challenge of establishing fair value varies significantly depending on the location and tenant mix. For example, the office markets of New York City, San Francisco and Chicago are struggling with high vacancy levels, whereas companies in Dallas and Houston have been more ready to call workers back to offices.
“It’s more important than ever to be out in the market, talking to the players in all different facets of office, which gives you little nuggets related to market conditions,” Enloe says. These insights, he adds, come from property managers, leasing brokers, tenants, developers, owners and investment-sales brokers. “It’s never been more important to talk to all the players, because there’s varying perspectives.”
A lack of hard data will likely remain a challenge for some time. According to Real Capital Analytics, office sales volume increased moderately this past March but was down year over year by 36% in first-quarter 2021. Given the uncertainty about how many companies will extend remote-working arrangements, Enloe says, occupancy levels and rents for office properties also are likely to remain unclear, at least until next year.
“I view June through September as the sweet spot when people will say, ‘OK, we’re back. The office is back open, let’s come in,’” Enloe says. “Through the end of this year and probably through the first quarter of 2022, there will be an assessment of the current space and really understanding which team members want to come in, which team members don’t and what jobs require collaboration. So, I think, we’re about a year away from companies really crafting their space plans.”
Richard West, general manager of the lender and valuation segments at LightBox, says that an office building’s individual story has never mattered more. An office property that has lost a single major tenant, for example, will be in a different position than one with several long-term tenants that have temporarily sent workers home.
“You have to do a deeper dive into the transaction,” West says. “What the appraiser has to do is really drill in and understand exactly what the story behind the story is on each of those trades.”
Appraisers usually look at recent comparable sales and income history to establish value, but today’s market requires more work on the part of appraisers, West says. “The reality is that they’re going to have less data,” he notes. “And so, they’re going to call buyers, they’re going to call sellers, they’re going to call brokers and they’re going to ask for their opinions.”
This uncertainty will likely continue to put pressure on office values while possibly keeping buyers and sellers apart. Lucas Rotter, CEO and co-founder of the appraisal platform Valcre, says that office buildings have already depreciated.
“When the rents go down, that pushes value down, because the way that office buildings are valued is based on their contract rents and, you know, no one really is signing 10-year leases right now because there’s so much uncertainty,” Rotter says. “And so, a lot of these landlords are cutting concessions to their tenants to keep them in place and keep [values] kind of artificially stabilized in some areas.”
Rotter notes, however, that other asset types also have some uncertainty that is making the appraisal process challenging. Apartment owners, for example, have been forced to allow tenants to defer rent and have been unable to generate as much income from their properties.
“It’s tough for appraisers out there right now when they’re valuing assets because there is a lack of data,” Rotter says. “So, it’s requiring appraisers to really sharpen their pencils and dig in on those details, and get into the weeds and figure out what’s going on with these transactions.” ●