The office sector is in an undeniably challenging position. But, just like retail properties adapted to meet extreme changes in its marketplace several years ago, so too will office, according to a new Q2 report from Marcus & Millichap.
Retail had its e-commerce crisis and office has its work-from-home and now its “debt obligations coming due” dilemma.
Office owners who took out debt five or seven years ago are now facing a much tighter lending environment, where costs of capital have gone up substantially, outpacing rental incomes.
“This creates the potential for properties to fall into delinquency, prompting a distressed sale,” according to the report.
Distress, however, is regionally distinguished with the West and Northeast under the most pressure.
“Lenders are not necessarily interested in acquiring more office properties, creating an incentive for financial institutions to work prudently and constructively with creditworthy borrowers, as recommended in a recent statement released by federal financial institution regulatory agencies,” according to the report.
Not All That Bad
Taken as a whole, the office sector looks well-worn. However extreme outliers such as the San Francisco market are creating more frightening metrics.
The US vacancy rate is forecast to reach a record-high 17.3 percent by the end of 2023, Marcus & Millichap said, while the mean asking rent will flatten. More office space is also expected to be let go than leased this year, to the tune of over 24 million square feet of negative absorption.
Consider, however, as of June, West Palm Beach, Miami-Dade, and Las Vegas reported vacancy rates that were lower than their year-end 2019 marks.
Remote work has dominated the office headlines for several years, and these incentives to work from home are unlikely to disappear, Marcus & Millichap said, but “they are certainly segmented across industries and regions. Areas with more convenient commutes, or that have more industries that require data security, will record a greater in-person work presence.”
Mixed-Use a Reasonable Alternative
Looking ahead, the office sector could go the way of trying to make in-person work more convenient for employees through mixed-use properties.
“Owners who are able may see a benefit to adding retail options in their properties,” according to the report.
Traditional office buildings can also be renovated to attract medical office tenants and boost occupancy, the report said.
“As with retail, the technology that disrupted the office sector may one day be used to its benefit. Over time, a more seamless integration of virtual and physical collaboration space could be developed. Better telepresence technology could allow hybrid flexibility to mix with a physical office presence.”
Marcus & Millichap calls out that the struggles office spaces face today “open the sector up to a dynamic period of reinvention. Ultimately, a new trend will emerge, perhaps guiding offices in an unexpected direction.”