There is little use in sugarcoating the challenges that face the U.S. office sector, but it’s not the end times either. That is the outlook according to Doug Ressler of Yardi Matrix, one of the authors of the commercial real estate data research company’s national office report released this past September.
“The banks do not want to take the properties back like they did in 2008.”
The report offers a sobering picture of the current office environment and offers ideas for how long it may take before a recovery begins. Scotsman Guide spoke with Ressler in September to get his perspective on the office sector’s current woes, along with what can be expected in 2024.
Office experts are throwing around words such as ‘apocalypse’ to describe the U.S. office sector. Are these terms appropriate?
Well, I don’t think it’s an apocalypse like some people want to paint it. I don’t believe it’s that bad. There’s no question the office market is in a downward trend. But at the same, the banks do not want to take the properties back like they did in 2008. The institutions are trying to work out deals to extend the loans as they come due. Now, that won’t occur for 100% of the properties, but we believe that most buildings will find a financial solution. However, a loan extension doesn’t mean that the property owners won’t have to put more equity into the deal to make it work.
Your national office report states that the U.S. vacancy rate has reached 17.54%, a record surpassing 2008 levels. And one of the hardest-hit places is the Bay Area?
That is correct. We are seeing that the cybersecurity and banking folks are populating San Francisco offices more routinely. That doesn’t mean they are in their offices Monday through Friday, but they are back in the office more because their work can only be done from a central core office. Then you have the general technology sector, which has been really hammered hard with many remote workers. We anticipate it’s probably going to stay down, especially if we experience a recession in the near term. So, you have roughly 30% of the folks going back because their jobs demand it and another 30% of tech workers who don’t want to go back to the office. And then there is everyone else who is saying they feel empowered and really want to be in the office less than five days a week.
You say the return-to-the-office push isn’t over yet. Who is still holding out?
The next two years will be stabilizing periods, with each market being unique in terms of occupancy return statistics. Financial institutions and information technology companies have resumed a return-to-work policy, including a major push by Amazon.com. The federal government has indicated that employees need to go back, but even prior to the pandemic, the government was planning to downsize many offices. When the pandemic hit, obviously we saw a diaspora of government workers outside the office. The federal government hasn’t mandated in the way that Google or Disney has, for instance, but they have indicated that they want employees back in the office.
Large metro areas with the most office space in the supply pipeline include Boston, Seattle, San Francisco and Manhattan. What will be the impact?
We really think the urban cores are going to get hit hard. Boston might be an exception, but the urban cores of New York City, Philadelphia, San Francisco and many others are going to be hit harder than anywhere else because they just haven’t been populated like other urban cores, and that will slow recovery. It’s economics 101: More supply drives down demand and prices.
Your report also points out that Class A+ and A buildings have dropped in value.
That information was from a study by Trepp. They found that buildings rated ‘A+’ or ‘A’ traded for $361 per square foot in 2022, but only $233 per square foot in 2023, a decrease of 35%. The results surprised them. Keep in mind there were only a few transactions on which to base these results. But still, I don’t think there’s any givens in the office market right now.
You believe that quarterly property transactions will stay extremely low until 2025 or 2026?
That’s right — because these issues must be worked through. First, the buyers and sellers must have a sense of when the Federal Reserve will stop raising rates. Also, there’s what I call the ‘Godot recession.’ We are still waiting for it. There is the issue of surplus inventory that must be worked through, so you’ve got a combination of negatives that are knocking the heck out of the industry.
How long will it take to work through these? There is a lag effect for sure, so right now we are saying 2025 to 2026. A lot of people have said that eight to nine months after interest rates stop rising, things will take off. That rule of thumb doesn’t apply anymore. Next year is not going to be great. It just isn’t going to happen. Not the way we see it. ●