Following the collapse of banks on both coasts last month, financial markets are jittery, and the lingering threat to commercial real estate is significant, with a litany of issues, primarily tracing back to pandemic restrictions, affecting office and retail real estate.
Office vacancies are distressing lenders, as evidenced by the February default of Brookfield Asset Management on its twin 52-story towers in Los Angeles.
Additionally, in a deal consummated March 30, downtown Los Angeles’s Union Bank Plaza sold for $104 million. The building previously sold in 2010 for $208 million, underwent a $22 million renovation, and was reportedly listed for as much as $250 million in 2021.
Another commercial building at 4 Hutton Center in Santa Ana tells a similar tale. Built in 1988, it sold for $55.4 million in 2019 and was just resold in February for $25 million, according to sales data.
And with remote work becoming more common, AI taking over some jobs, and brick-and-mortar retail increasingly moving to online sales, vacancies are expected to increase, according to experts.
Cushman & Wakefield, in its 2023 report analyzing the national office sector, estimated 1.1 billion square feet of empty, unused office real estate by 2030. In comparison, the report lists pre-pandemic data showing 689 million square feet of empty office space.
The St. Louis Federal Reserve reports an estimated $2.9 trillion in commercial real estate loans nationwide, according to Forbes, and with transactional volume slowing to a crawl following the pandemic and subsequent interest rate increases, some traders say they are fearful, as reported by financial analysts, these liabilities could exacerbate liquidity issues that led to the collapse of banks last month.
“The office real estate market, in general, is in bad shape,” said Mark Coffey, principal and managing broker of Orange County Commercial Real Estate, Inc. “Volume has fallen way behind, driven by interest rates, as the cost of borrowing has almost doubled in nine months.”
Another factor impacting sales is the variability in office real estate quality, as recently reported by industry experts and highlighted by the National Association of Realtors. Vacancy rates differ drastically between modernized structures and dated facilities.
“Buildings built pre-1980 are becoming obsolete,” Coffey told The Epoch Times March 28.
Commercial sales have declined, according to Joseph J. Ori, CEO of Paramount Capital, a California Bay Area-based real estate firm, as bid-ask spreads, the difference between what buyers are offering to pay and sellers willing to accept, have increased. Higher financing costs are hampering buyers, and sellers have yet to respond by lowering asking prices.
Currently, “[t]he bid-ask spread in commercial real estate is wider than the Grand Canyon,” Ori said.
In the winter 2023 edition of their annual Commercial Real Estate Survey, real estate experts from California law firm Allen Matkins, and UCLA Anderson School of Management forecast a challenging three-year period for office and retail sectors starting in 2023, due to a change in office-use policies in workplaces and the possibility of a recession.
Vacancy rates for office real estate in Los Angeles have risen every quarter since the pandemic began, and currently sit at approximately 15.1 percent, according to a report published by NAI Capital, a global commercial real estate services firm.
By the Numbers
Goldman Sachs economists wrote in a report released March 16, that approximately 80 percent of commercial real estate lending comes from regional banks with less than $250 billion in funding.Regional banks in California face risks, according to financial analysts, as deposits were drained from smaller institutions in response to the collapse of Silicon Valley Bank and turmoil at First Republic. The fallout from failings in past weeks created stress on smaller banks, and how this will impact commercial real estate remains to be seen.
In order for the sector to thrive, job growth and low-interest rates are needed, as noted in the UCLA report, but the current climate includes a number of layoffs across industries and the Federal Reserve raising rates at the fastest pace in decades.
The March 22 announcement of a further increase to 4.75 percent puts additional stress on commercial real estate and bond markets, according to the UCLA report, the same investment instruments troubling financial institutions and that precipitated the March 10 collapse of Silicon Valley Bank.
Many industry experts are expecting the Fed to ease tightening, including former FDIC chair Sheila Bair, and if the fund rate remains flat for the remainder of the year, some are looking for commercial real estate to rebound in the fourth quarter.
Looking For Opportunity
Analysts believe there are areas where commercial opportunities still exist for investors.Hotel investments have proven profitable, and the travel boom that followed the listing of pandemic restrictions offers the potential for more growth, they advise.
Some see retail as another option, but e-commerce, shoplifting, and crime in major cities make retail a riskier proposal, they say, and a 2016 study in the Journal of Regional Science, a peer-reviewed publication studying urban research and analytical planning since 1958, concluded that crime reduces commercial real estate valuations.
According to Coffey, the managing broker of Orange County Commercial Real Estate, Inc., there are also significant opportunities for repurposed facilities.
The trend toward turning unused commercial real estate space into multi-family housing is progressing, with approximately 77,000 apartments nationwide in the process of such a conversion as of 2022, according to Yardi Matrix, a commercial research firm.
But some, like Ori, the CEO of Paramount Capital, argue it will take a change of leadership to solve the dilemma.
“Until the governance changes, those urban gateway cities’ office markets are really going to suffer,” he told The Epoch Times. “Most of the pundits are afraid to say it, or maybe they don’t know, but that’s what’s truly happening.”
