Collin Madden, founding partner of GEM Real Estate Partners, walks through empty office space in a building they own that is for sale in the South Lake Union neighborhood of Seattle, Washington on May 14, 2021.
Karen Ducey | Reuters
Some things we know about commercial real estate: It’s a cost-cutting goal for businesses, but it’s also probably the last asset you want to sell now in a soft market.
How sweet? According to Elizabeth Ptacek, senior director of market analysis at commercial real estate information and analysis firm CoStar, there are currently 232 million square feet of excess commercial real estate available for sublease. To put those numbers into perspective, Amazon’s headquarters measures 8 million square feet. Even more telling, the 232 million square feet is double the pre-pandemic surplus level.
CFOs have told us that as their companies move to hybrid work and corporate hub models that make less, if any, use of satellite offices, there is real estate for sale. And they’re not selling it now. Ptacek says it’s the right decision.
The only real estate owners selling today are either strapped for cash or sitting on trophies. And these trophies are few and far between. Well-leased medical offices and labs with high-credit tenants and secure revenue streams still get a lot of investor attention, but that’s about it, according to CoStar. Any business that has given up a satellite office that was once essential for its current staff is sitting on a property that Ptacek says “no one will buy for anything less than a substantial discount.”
Between the commercial real estate shock from the remote work trend, followed by rising interest rates and the prospect of another recession, now is not the time to sell even though Ptacek says the Commercial real estate owners should expect the situation to get even worse. CoStar predicts the sublease glut will persist as companies fear they may have to lay off workers and make other cuts before a recession, and it goes further: Sublease square footage will never return to levels from before the pandemic, she said.
The slowdown in investment activity that Ptacek described as a gradual slowdown so far, will become a “dramatic slowdown” after the pipeline of deals signed in the second and third quarters closes before rates begin to rise . “The biggest impact is ahead of us, and the higher cost of borrowing will impact and in many cases eliminate leveraged investors,” she said.
It’s a bad situation, but she said that for business real estate owners, if the cost of real estate debt is cheap and the balance sheet is strong, sit on the real estate.
While companies are still in the early days of their hybrid working experiments, it is not just economic uncertainty, but also uncertainty about how office occupancy will change over time, that should encourage companies not to pull the trigger on asset sales. Leases that needed to be renewed were an easy call to make (end them), and businesses can always sign new leases (likely at even better rates) if and when they need to make that call.
“Everything is still shaking and you see it, you see big corporations one day completely remote and the next day signing huge leases and telling everyone, ‘Back in the office’, then the minute they do, the employees express their dismay and they say, ‘It’s okay.’ Everything is changing,” Ptacek said.
Uncertainty is the ultimate killer, she said. No one wants to buy assets with the risk of no demand unless rents fall by 50%. It’s difficult right now, she says, for either the buyer or the seller to achieve what would be defined as a “reasonable price.”
Businesses should expect the situation to be even worse a year from now.
“It’s probably a fair assumption that it’s not going to be much better in a year, in terms of demand,” she said. “There could be another leg down in transactions.”
The wave of struggling sales that typically occurs in downturns hasn’t happened yet, and it’s on schedule, as they tend to delay the onset of downturns by a few years. Ptacek noted that after 2008, the peak of the wave of distressed asset sales did not occur until 2010/2011.
“When the loans come due and they’re in trouble, it’s refinance or sell,” she said. And more borrowers will not be able to refinance, and the wave of distressed sales will ensue. “There will probably be some level of distress that will weigh on prices, so you as a landlord could find yourself in a position in a few years where the environment is even less favorable. But it’s not as if it was a good environment today,” she said. said.