Office Appraisal, Valuation Gaps Are Bad For Business

The office sector continued its struggle in 2024 with more appraisal and valuation gaps, as reported by GlobeSt. With lenders losing patience, many properties are under pressure as previously manageable issues become unsustainable.

Valuation, Appraisal Gaps

Valuation discrepancies have widened in many office markets, with appraisals often failing to reflect the real financial health of properties. Jim Costello of MSCI Research noted that private equity clients frequently asked whether their asset value cuts were on par with their peers—a situation that shouldn’t arise if appraisals were truly impartial. 

In some high-profile cases, investors have seen steep losses despite investing in top-rated securities tied to well-established real estate assets. For example, AAA-rated securities backed by the $308M debt of 1740 Broadway in Midtown Manhattan returned only 74% of their original value after the loan was sold at a massive discount. 

Bloomberg’s research suggests that investors in several single-asset, single-borrower (SASB) deals tied to office buildings may only recoup a fraction of their investments, with losses extending to even the AAA tranches.

Global Wounds

Some foreign investment groups, particularly from South Korea, have seen their investments in US office towers collapse or get wiped out completely:

• IGIS Asset Management, for example, sold its subordinated debt on 1551 Broadway in NYC at a heavy discount after the property’s value plummeted.
• Meritz Alternative Asset Management, a mezzanine lender on LA’s Gas Company Tower, saw its valuation drop by 56.7% in just two years, from $623M in 2021 to $270M in 2023.

These international investors are now cutting their losses and exiting properties at discounts, unable to recover their original investments due to the rapidly changing dynamics of the office market.

Lessons Learned

Several key lessons are emerging from this crisis. Experts stress that property owners and investors must employ multiple, independent methods to track valuations. 

Updated appraisals and the use of unbiased third-party datasets are essential to painting a more accurate picture of property value, as opposed to relying on self-serving valuations that might mislead stakeholders.

Anticipating capital needs is also crucial. Property owners must be prepared for potential capital injections and consider strategic shifts to more valuable properties. In some cases, accepting losses and redirecting resources may be the most prudent course of action. This proactive approach could help lessen the damage from market downturns.

High-Profile Deals

Several high-profile transactions show a wide disparity in valuation outcomes. SL Green Realty Corp. (SLG) sold an 11% stake in One Vanderbilt, a Class-A office building near Grand Central Station, for a sum that valued the building at $4.7B. Trophy and Class-A office properties like One Vanderbilt have been better at maintaining value due to sustained demand from tenants and investors.

However, other deals have been far less favorable. Beacon Capital Partners and 3Edgewood acquired a majority stake in the $485M senior loan on Pacific Corporate Towers in El Segundo, CA, at a 60% discount from the original purchase price by Starwood Capital Group (STWD) and Artisan Realty Advisors. In this case, the sellers opted to hand over the deed instead of facing foreclosure.

Why It Matters

The widening valuation gaps and financial difficulties in the office sector have significant ramifications for investors, lenders, and the broader CRE market. More office properties may face financial hardship, leading to more losses for investors and lenders.

As lenders lose patience and properties face the real consequences of overvaluations, it’s clear that the office sector’s future will depend on more accurate, transparent valuations.