$38B Worth of US Office Buildings Face Historic Defaults

A record-high $38 billion in U.S. office buildings face defaults and other distress, echoing the distress of the post-2008 financial crisis period.

Jordan B. & Han-Gwon Lung
May 01, 2024

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Good morning. A record $38 billion in U.S. office buildings are at risk of default. Regulators have seized another regional bank, the first failure this year to make headlines. Plus, today’s chart shows multifamily rent growth remains stable at 0.4%, expected to pick up in late 2024.

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Market Snapshot

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GSPC

5,035.69

Pct Chg:
-1.57%

FTSE NAREIT

FNER

681.96

Pct Chg:
-1.78%

10Y Treasury

TNX

4.69%

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+0.006

SOFR

1-month

5.33%

Pct Chg:
0.0%

*Data as of 4/30/2024 market close.

LOAN DISTRESS

$38B in Peril as US Office Buildings Face Historic Defaults

Historic Highs in Office-Loan Defaults: Over $38 Billion at Risk

The U.S. office market is experiencing turmoil as over $38B of office buildings are at risk of loan defaults, foreclosures, or distress, the highest level since 2012.

Mounting defaults: According to MSCI, more than $38B worth of U.S. office buildings are currently threatened by defaults, foreclosures, or distress. This is the highest amount of distress since the aftermath of the GFC. The culmination of persistently high interest rates and reduced demand has pushed office loan defaults to historic highs.

Slow repayments: High interest rates and a significant shift in office demand due to the pandemic have led to a stark decrease in loan repayments. In 2021, more than 90% of office loans were being cleared at maturity; by last year, this rate had dropped to a mere 35%. This change reflects property owners’ broader economic challenges, including higher financing costs and lower occupancy rates.

Zoom in: Tenants are increasingly wary of leasing spaces from financially unstable landlords, fearing disruptions in their occupancy. Landlords, in response, are forced to invest in property upgrades to attract and retain tenants. Notable examples include significant investments in amenities by the new owners of Aon Center in Los Angeles, aimed at revitalizing tenant interest.

➥ THE TAKEAWAY

Why it matters: Post-pandemic office market disruptions have led to a record vacancy rate of 13.8%, up from 9.4% at the end of 2019, per CoStar. Declining demand due to remote work policies has also resulted in lower leasing activity, with tenants requiring about 10% less square footage compared to the 1Q19 average. Despite doom and gloom, some investors are seizing opportunities to purchase distressed properties at significant discounts.

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✍️ Editor’s Picks

Where to invest: Industry pros offer their best ideas on where to deploy cash in commercial and residential property.
Narrowing losses: Cushman & Wakefield’s (CWK) saw $2.2B in Q1 revenue, down 3% YoY, with a $29M loss, 62% lower YoY. The firm expects stronger Q2 capital markets growth, too.
Big, bold plan: The New York State Teachers’ Retirement System (NYSTRS) pledged $534.88 million in follow-on investments to four of its existing real estate fund managers.
Yield curve clues: Extended yield curve inversions usually signal on oncoming recession, but when is this one coming, exactly?
Promising performance: In 1Q24, the single tenant net lease market saw 26% more investment sales, totaling $11.2B, with average cap rates rising to 6.5%.
Texas tech takeover: Dallas is emerging as a top proptech hub, attracting 17 new HQs and $2.3B in new investments since 2020.

🏘️ MULTIFAMILY

Harlem harmony: Developer Bruce Teitelbaum relaunches a Harlem apartment tower project at 145th St and Malcolm X Blvd after previous setbacks.
Cracking the code: In this episode of Tax Credit Tuesday from Novogradac, learn how eligible basis rules impact low-income housing tax credits.
Population boom: Four Texas metro areas, led by Dallas-Fort Worth surpassing 8 million residents, are among the nation’s top population gainers from 2022 to 2023.
Pacific partnership: Kennedy Wilson (KW) and Haseko Corp. acquire 350 multifamily units in Vancouver for $90M, expanding Kennedy Wilson’s North American presence.
Salt of the earth: The Wasatch Group sold the 240-unit Crossroads Apartments complex in West Valley City, UT, a suburb of Salt Lake City, with a $32.5M Freddie Mac (FMCC) loan.
Rent adjustment: The Rent Guidelines Board approved rent hikes of 2-4.5% for one-year and 4-6.5% for two-year leases in rent-stabilized apartments, and froze rents for stabilized hotels.

🏭 Industrial

Seattle success: CenterPoint Properties sells the Pike Distribution Center in Auburn, WA, a 108KSF building, to KRL Legacy LLC for $26.6M.
Historic revamp: A Houston development team focusing on adaptive reuse has set their sights on a historic industrial building in the Heights for their next project.
Garden State glory: Bridge Industrial secures $28.5M in financing for a 167.3K SF warehouse project in South Plainfield, NJ.
Revamping charm: Blue Ridge Industrial selects Stream Realty Partners to lease a 1.4M SF portfolio with 28 buildings in North Carolina.

🏬 RETAIL

Grounded groceries: A new report from Marcus & Millichap (MMI) shows that the U.S. grocery sector outlook remains strong despite inflation in restaurants.
Office milestone: American Eagle Outfitters signs a 20-year lease for 338KSF at 63 Madison Ave, the largest NYC lease in 2024.
Cornerstones: According to a recent Pacer.ai analysis, everyone’s favorite neighborhood corner stores are thriving and expanding into dining spaces.

🏢 OFFICE

Buying the block: Quantic Wenzel secures 45.3K SF at Kramer 1 in Austin, leasing 75% of the building in the country’s second-largest Q1 deal.
High stakes: Nuveen Real Estate has listed its 701 Brickell office tower in Miami for over $500 million, becoming the fourth property in the financial district to be put up for sale since last fall.
Work trends: A survey by Federal News Network reveals that 30% of federal employees work entirely remotely, 6% work fully on-site, and 64% combine telework with office duties.

BANK FAILURE

Republic First Bank Seized With $1.7B Of CRE Loans On Its Books

A Manhattan branch of Republic Bank (Republic First Bank) in 2017 (Wikimedia).

Last week, Republic First Bank was seized and sold, marking the first regional bank failure to make headlines this year. The downfall was attributed to unrealized loan losses exacerbated by high interest rates.

Another one: With just $6B in total assets, Republic First Bank faced reported $42M in 1Q24 losses. The takeover, orchestrated by regulators, saw all 32 bank branches in NJ, PA, and NY transition to Fulton Bank, doubling its presence in the Philadelphia market. After Republic First Bank’s closure, Fulton Financial acquired deposits and assets totaling $2.9B in loans.

Lending troubles: According to an investor presentation in July, by the end of Q1 last year, commercial real estate constituted under 30% of the bank’s loan portfolio. This included $895 million in commercial real estate, $304 million in construction and land development, $570 million in owner-occupied real estate, and $992 million in residential loans. The bank’s troubles also included a delisting from NASDAQ in the previous year and repeated leadership changes.

Taking precautions: Material weaknesses in bank controls raised concerns, leading to the FDIC initiating proceedings to seize Republic First Bank late last year. Efforts to negotiate a $35M capital injection to avert a failure were unsuccessful, resulting in the bank’s seizure. The FDIC’s insurance fund will incur costs of approximately $667M due to the closure.

➥ THE TAKEAWAY

Zoom out: Republic First’s collapse, the sixth-largest bank failure since 2010, is likely to have minimal impact on commercial real estate. However, the collapse highlights ongoing concerns about deposit stability in smaller banks, potentially driving further consolidation in the banking sector. This consolidation could restrict lending options in smaller markets, which often depend heavily on regional and community banks for CRE investments.

📈 CHART OF THE DAY

According to CBRE’s 2024 Multifamily report, rent growth remained stable at 0.4% in Q4, with expectations to stay flat before rising in late 2024. The multifamily vacancy rate edged up by 10 basis points to 5.5% quarter-over-quarter and may increase slightly by midyear despite ongoing job growth and household formation.