Distress in Office Market Spreads to High-End Buildings

The amount of U.S. class-A office space in central business districts that is leased fell in the fourth quarter of last year for the first time since 2021, according to

Moody’s

Analytics. The owners of a number of high-end properties recently defaulted on their mortgages, highlighting the financial strain from rising interest rates and vacancies. 

“Any property owner that says ‘Oh we’re fine’ is a little bit fooling themselves,” said Thomas LaSalvia, director of economic research at Moody’s Analytics.

Some office landlords invested heavily in their buildings in recent years, adding spas, gyms, restaurants and modern elevators. The hope was that by modernizing their properties, these owners could benefit from a flight to quality as more tenants seek out environmentally friendly buildings with plenty of amenities and natural light. 

This strategy has worked for some buildings, especially those developed in the past decade. Some new buildings like One Vanderbilt in Manhattan managed to add tenants at high rents.

But new leasing data and recent defaults indicate that many of these high-end properties aren’t immune to the office market’s crisis. 

Take 777 South Figueroa St. in downtown Los Angeles. Completed in 1991, the 52-story tower features a lobby with 30-foot ceilings and rose-marble-covered walls, a landscaped plaza, valet parking and concierge services. Many of its tenants are financial companies and law firms, according to data from

CoStar Group.

The owner, Brookfield Asset Management, recently defaulted on more than $750 million in debt backing the building and another Los Angeles tower. Meanwhile, asset manager Pimco recently defaulted on a mortgage backed by a portfolio of office buildings including Twitter offices in New York and San Francisco.

Older high-end properties are struggling in part because they face competition from towers built in recent years. In downtown Los Angeles, 28 office buildings have been completed since 2000, according to Moody’s Analytics. 

In New York, new developments like One Vanderbilt and Hudson Yards have lured tenants from Park Avenue towers while pushing up Manhattan’s overall vacancy by adding new supply. Close to 19% of all high-end office space in Manhattan was available for lease in the fourth quarter of 2022, according to brokerage

Savills,

up from 11.5% in early 2019. 

The availability rate for top-shelf office space was slightly higher than the availability rate at cheaper class-B and class-C buildings, Savills said.

Rising interest rates have hit the entire commercial real estate sector hard. Higher mortgage costs eat into landlords’ earnings and make it harder to refinance expiring loans. Rising yields on bonds and other securities also make real estate look less profitable in comparison, making buyers more reluctant to pay high prices and pushing down property values. Real estate analytics firm Green Street recently estimated that U.S. property values are down 15% since March 2022.

Not all commercial property sectors are suffering equally. While the values of hotels and rental-apartment buildings have fallen, these properties are also benefiting from inflation, which is pushing up room rates and apartment rents. Office buildings have seen a steeper drop in values partly because they are also grappling with weak demand from tenants who are cutting back on workspace. Green Street estimates that office values are down 25% over the past year.

During a recent earnings call, the president of office landlord Boston Properties Inc. Douglas Linde said many office buildings are obsolete and could be converted to other uses such as apartments. “A meaningful amount of the existing office inventory may have a higher and a better use as an alternative product, and it’s not relevant to users searching for space today,” he said.

Analysts expect office defaults to increase as more mortgages that were signed before the pandemic expire. Around $2.6 trillion in commercial mortgages are set to mature between 2023 and 2027, according to Trepp Inc. Many of these loans are held by smaller banks.

Pressure on office occupancy is expected to continue for much of 2023. Weakening demand during the pandemic era initially came from companies cutting back on space by letting employees work from home part of the week. Now demand also is tumbling because big technology companies are hunkering down and cutting expenses for fear of a possible economic downturn.

Landlords who benefited from long-term leases are becoming more vulnerable as leases signed before the pandemic expire. Michael Silver, chairman of Vestian Global Workplace Services, said law firms he advises on their real estate often look to cut their space by around 30% when their leases expire. And unlike in 2021, more companies are worried about a recession and looking to cut costs.

“That’s just going to contribute to overall vacancy, and it doesn’t matter whether you’re in an A building or a B building,” he said.

Write to Konrad Putzier at [email protected]

Corrections & Amplifications
Pimco recently defaulted on a mortgage backed by a portfolio of office buildings including Twitter offices in New York and San Francisco. An earlier version of this article and a photo caption incorrectly said the portfolio included the Twitter headquarters in San Francisco. (Corrected on March 28)

The amount of U.S. class-A office space in central business districts that is leased fell in the fourth quarter of last year for the first time since 2021, according to

Moody’s

Analytics. The owners of a number of high-end properties recently defaulted on their mortgages, highlighting the financial strain from rising interest rates and vacancies. 

“Any property owner that says ‘Oh we’re fine’ is a little bit fooling themselves,” said Thomas LaSalvia, director of economic research at Moody’s Analytics.

Some office landlords invested heavily in their buildings in recent years, adding spas, gyms, restaurants and modern elevators. The hope was that by modernizing their properties, these owners could benefit from a flight to quality as more tenants seek out environmentally friendly buildings with plenty of amenities and natural light. 

This strategy has worked for some buildings, especially those developed in the past decade. Some new buildings like One Vanderbilt in Manhattan managed to add tenants at high rents.

But new leasing data and recent defaults indicate that many of these high-end properties aren’t immune to the office market’s crisis. 

Take 777 South Figueroa St. in downtown Los Angeles. Completed in 1991, the 52-story tower features a lobby with 30-foot ceilings and rose-marble-covered walls, a landscaped plaza, valet parking and concierge services. Many of its tenants are financial companies and law firms, according to data from

CoStar Group.

The owner, Brookfield Asset Management, recently defaulted on more than $750 million in debt backing the building and another Los Angeles tower. Meanwhile, asset manager Pimco recently defaulted on a mortgage backed by a portfolio of office buildings including Twitter offices in New York and San Francisco.

Older high-end properties are struggling in part because they face competition from towers built in recent years. In downtown Los Angeles, 28 office buildings have been completed since 2000, according to Moody’s Analytics. 

In New York, new developments like One Vanderbilt and Hudson Yards have lured tenants from Park Avenue towers while pushing up Manhattan’s overall vacancy by adding new supply. Close to 19% of all high-end office space in Manhattan was available for lease in the fourth quarter of 2022, according to brokerage

Savills,

up from 11.5% in early 2019. 

The availability rate for top-shelf office space was slightly higher than the availability rate at cheaper class-B and class-C buildings, Savills said.

Rising interest rates have hit the entire commercial real estate sector hard. Higher mortgage costs eat into landlords’ earnings and make it harder to refinance expiring loans. Rising yields on bonds and other securities also make real estate look less profitable in comparison, making buyers more reluctant to pay high prices and pushing down property values. Real estate analytics firm Green Street recently estimated that U.S. property values are down 15% since March 2022.

Not all commercial property sectors are suffering equally. While the values of hotels and rental-apartment buildings have fallen, these properties are also benefiting from inflation, which is pushing up room rates and apartment rents. Office buildings have seen a steeper drop in values partly because they are also grappling with weak demand from tenants who are cutting back on workspace. Green Street estimates that office values are down 25% over the past year.

During a recent earnings call, the president of office landlord Boston Properties Inc. Douglas Linde said many office buildings are obsolete and could be converted to other uses such as apartments. “A meaningful amount of the existing office inventory may have a higher and a better use as an alternative product, and it’s not relevant to users searching for space today,” he said.

Analysts expect office defaults to increase as more mortgages that were signed before the pandemic expire. Around $2.6 trillion in commercial mortgages are set to mature between 2023 and 2027, according to Trepp Inc. Many of these loans are held by smaller banks.

Pressure on office occupancy is expected to continue for much of 2023. Weakening demand during the pandemic era initially came from companies cutting back on space by letting employees work from home part of the week. Now demand also is tumbling because big technology companies are hunkering down and cutting expenses for fear of a possible economic downturn.

Landlords who benefited from long-term leases are becoming more vulnerable as leases signed before the pandemic expire. Michael Silver, chairman of Vestian Global Workplace Services, said law firms he advises on their real estate often look to cut their space by around 30% when their leases expire. And unlike in 2021, more companies are worried about a recession and looking to cut costs.

“That’s just going to contribute to overall vacancy, and it doesn’t matter whether you’re in an A building or a B building,” he said.

Write to Konrad Putzier at [email protected]

Corrections & Amplifications
Pimco recently defaulted on a mortgage backed by a portfolio of office buildings including Twitter offices in New York and San Francisco. An earlier version of this article and a photo caption incorrectly said the portfolio included the Twitter headquarters in San Francisco. (Corrected on March 28)