2024 – Navigating Distressed Office Markets: A Financial Lens for CFOs

by Cushman Wakefield, Special Edition Newsletter contributors

The current office market landscape is witnessing a pronounced downturn, primarily catalyzed by the pervasive adoption of hybrid work models, resulting in substantial disruptions across major central business districts (CBDs) in the United States. This paradigm shift is significantly impacting non-trophy Class A office assets without views or other features that welcome workers to the office. Non-trophy office assets that were sold or recapitalized post-2016 are poised to confront challenges as the leases of the building expire, potentially leading to debt service issues. Conversely, trophy assets, particularly those offering views, have experienced an upward trajectory in rental rates as many companies with strong return to office adoption have sought to upgrade their space. Premiere locations that offer amenities workers seek such as Salesforce Tower in San Francisco and Two Vanderbilt in New York City are not experiencing the same decline in demand as their non-view, tertiary location competitors. However, buildings without views or privileged locations are commodities and currently there is an over-supply of these buildings. Coupled with a decrease in demand as a result of Hybrid work or work from home, we find office markets that are challenged. In that context, major CBDs such as San Francisco, Seattle, New York, Los Angeles, and Chicago, along with smaller tertiary markets, are grappling with dwindling demand for office space.

In contrast to the aftermath of the Global Financial Crisis (GFC), where it took seven years to alleviate distress across all property types, the current scenario suggests a more accelerated unwinding of the office asset class in major CBDs. The US Treasury yield rate’s descent below 4% has spurred active pursuit of distressed office market opportunities by value-add funds. Vacancy rates are ascending, and rental rates are on a downward trajectory. While this poses challenges for property owners, it presents an opportune moment for CFOs and their organizations, providing a plethora of flexible options.

Great options exist for companies who want to remain in their current space at a reduced rent or different footprint. For companies with leases set to expire within the next two years, lease restructuring emerges as a prudent financial strategy. Negotiating term extensions with property owners in exchange for reduced rents, reduced premises areas, and additional concessions can be an attractive financial maneuver. Depending on variables such as the building, space, and submarket dynamics, property owners may be receptive to trade-offs involving lower rents or free rent in return for a term extension, usually a minimum of three years beyond the current expiration, and perhaps longer depending on the concessions provided by the ownership. Those with expansion needs or improvement requirements may find property owners willing to offer tenant improvement for tenants willing to remain in the building. Quite simply, the name of the game for Landlords in this market is to retain your tenant roster and tenants can leverage this for an inexpensive deal.

For companies who want to change their workplace while avoiding significant capital expenditures and long-term lease commitments, subleases may be a great option. Most companies were over-subscribed in office space prior to the pandemic and this problem has been exacerbated by hybrid work models. Major urban CBDs still harbor a substantial inventory of sublease options, often available at a considerable discount compared to direct lease offerings. Many of these subleases may come equipped with reusable high-end furniture and audio-visual assets. While the absence of property owner funded tenant improvement allowances may be a drawback to a sublease structure, inexpensive rebranding and IT adjustments can mitigate this limitation. Other issues that could make a sublease a challenging option include the financial viability of the sublandlord and the multi-party documentation process, however, a good real estate professional should be able to assist in mitigating these risks. Subleases frequently offer superior spaces and furnishings compared to a tenant’s existing arrangement, providing a strategic opportunity to upgrade with shorter, cost-effective terms.

Amid ongoing rent compression and property owners’ aggressive efforts to retain tenants, buildings with available capital are enhancing concessions to attract new tenants. Since most companies need capital to offset costs associated with constructing new spaces and facilitating relocations, many property owners are commonly offering turn-key improvements and sizable free rent packages. Some trophy buildings, while maintaining their high rents, are supplementing deals with larger concession packages. Astute office building asset managers are proactively responding to the reduction in tenant demand by undertaking speculative improvements for smaller suites, enabling effective competition with the sublease markets. This strategic move aligns with the prevailing trend of heightened flexibility in real estate decision-making.

In this challenging business environment, CFOs, irrespective of their organization’s size, budget constraints, or capital expense budget, are presented with numerous financial opportunities take advantage of the declining office market. Not all buildings or sublease options can successfully transact or reduce rent or provide capital for improvements. Some subleases may be enhanced risks based upon the viability of the sublandlord. A strong real estate broker will be able to guide a company through these risks and uncertainties. The overall cost of real estate is anticipated to decrease for many companies, and depending on specific financial needs, most should be able to tactically execute their preferred financial strategies in this dynamically evolving market. The disruptions and challenges of the office building asset class will provide an opportunity for most companies to execute their workplace strategy far more inexpensively than in the run up to the pandemic.

About Cushman & Wakefield

Cushman & Wakefield (NYSE: CWK) is a leading global real estate services firm that delivers exceptional value for real estate occupiers and owners. Cushman & Wakefield is among the largest real estate services firms with approximately 50,000 employees in over 400 offices and approximately 60 countries. In 2021, the firm had revenue of $9.4 billion across core services of property, facilities and project management, leasing, capital markets, and valuation and other services. To learn more, visit www.cushmanwakefield.com or follow @CushWake on Twitter.

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