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US office buildings face $1.1 trillion obsolescence hurdle

(Bloomberg) — One of the tallest office towers in St. Louis lost 96% of its rated value. Denver’s former World Trade Center campus faces foreclosure. An oil company’s vacant Houston workplace sold for $67.4 million in damages to lenders this year.

According to Randall Zeisler, an independent consultant and former consultant, those properties make up 30% of American office buildings—an estimated $1.1 trillion worth—that are at high risk of becoming obsolete as tenants’ tastes change in the hybrid-work era. . Head of Real Estate Research at Goldman Sachs Group Inc.

Some companies are reducing their space. Others are gravitating to newly developed or recently overhauled offices that are eco-friendly, with plenty of fresh air and natural light, fitness rooms and food courts. Left behind are older buildings that would be expensive to renovate by today’s standards. As the value of those properties decline, some landlords are moving away.

“We are not saying that the bulldozers are coming en masse,” Geisler said. “But you’re going to see a reappraisal and, in some cases, a reuse of these buildings.”

Average US office prices are down 4% from their pre-pandemic levels, the worst performance of any type of commercial real estate, Green Street data through February shows. A deeper look shows a divided market: While prices for new, feature-filled offices are up about 15%, they’re down 20% for smaller, older properties, Zisler said.

In addition to $1.1 trillion of endangered buildings, another $1.1 trillion form a “measurable middle” with limited upside due to uncertainty about long-term demand and potential renovation costs, Zisler estimates.

According to Jones Lang LaSalle Inc., buildings that opened in 2015 posted an occupancy gain of more than 51 million square feet (4.7 million square meters) since Covid hit, while vacancies increased elsewhere. The split is most pronounced in large city markets where more than 70% of office stocks reported by brokerages are at least three decades old, such as New York, San Francisco, Los Angeles, Boston, Chicago and Philadelphia.

Workers have been delayed in returning to offices after sending them home two years after the pandemic lockdown. With many vowing not to go back to their old commute, companies are rethinking their real estate needs, with some downsizing or listing space for sublease. According to Green Street, demand for in-person space could fall 15% from pre-Covid levels over the next five years as remote or hybrid schedules become more common.

To get bald workers back to their desks, employers are looking to scattered offices with few perks of home. Many top-paying tenants, such as tech companies, only want buildings with a low carbon footprint, while regulations such as New York’s local Law 97 may require huge investments to meet energy goals.

Surrender

Renovation is not a guarantee of success for buildings in vulnerable locations. Empire State Realty Trust Inc added a gym and dining facility in 2019 to a Norwalk, Connecticut, building that was occupied by only 46% as of December. Chief Financial Officer Christina Chiu said on a conference call last month that the company would rather pay off a $30 million mortgage instead of spending more money to lease the space.

“The math favors handing the keys back to the lender,” said Danny Ismail, a senior analyst at Green Street. “Increasingly, it risks moving.”

Some lenders are giving MUFG Union Bank is selling a $190.8 million mortgage on its Chicago campus with its largest tenant, BMO Harris Bank, moving to a new riverfront tower this year. According to a marketing memo from JLL, the loan matures on March 31, placing the note buyer in a position to assume ownership on an “attractive basis relative to new construction”.

A spokesperson for MUFG Union Bank declined to comment. JLL data show, downtown Chicago’s office vacancy rate was about 31% at the end of 2021.

‘Alarm Bells’

Mortgage delinquency rates for offices are much lower than for hotel and retail properties because tenants are not using the space to pay off long-term leases and contract obligations. In a sign of increasing caution, some new mortgages include “cash trap” clauses that allow tenants’ payments to pass directly to lenders, rather than landlords, when in office, said Elizabeth Murphy, a real estate finance attorney with Alston & Bird LLP. Live in the dark for a long time.

“It rings alarm bells,” Murphy said in an interview from Charlotte, North Carolina.

Values ​​fall after the offense. Revaluations of 60 office buildings with distressed commercial mortgage-backed securities have declined an average of 67% over the past two years, according to data compiled by Bloomberg, adding up to more than $1.2 billion in collateral.

The biggest wipe out of that group was 909 Chestnuts in St. Louis, which was valued at $9.2 million in August, down from $207.3 million in 2014. Built in 1986 as the world headquarters of Southwestern Bell Corp., 1.2 million square feet of the building is available for lease, according to a broker presentation.

The property is under contract and the sale is expected to close this year, loan documents show. Colliers broker Tony Kennedy declined to comment.

Houston’s vacancy rate reached 28% in December, JLL reported, fueled by years of contraction in the US oil industry. Three Westlake Park, an empty former BP plc and ConocoPhillips office, was sold in January for approximately $21 million, resulting in a loss of $67.4 million to lenders, according to Crawl Bond Rating Agency LLC. The new owners plan to convert the offices into apartments.

In Denver, where downtown offices are 24% vacant, a loser is the former World Trade Center I and II tower, built in 1979 and valued at $176 million in 2013. The owners failed to find a buyer who would cover the $132 million mortgage and agreed to surrender the property, now called Denver Energy Center. A foreclosure is expected this month, according to loan data compiled by Bloomberg. A spokeswoman for the owner, Los Angeles-based Gemini Rosemont, did not respond to requests for comment.

Are doing more damage to landlords across the country.

“We’re going to see a huge drop in prices in obsolete buildings,” Zisler said. “You’ll see it in the next four years, maybe even earlier.”

© 2022 Bloomberg LP

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