Last year, investors amassed billions in anticipation of acquiring distressed real estate assets at considerable discounts. Yet, the expected deluge of deals didn’t materialize as office property owners managed to retain their assets. This scenario is changing rapidly, with office buildings now trading at steep markdowns, often below their loan values, heralding a surge in short sales.
Short sales, where properties sell for less than the outstanding loan and are executed with lender collaboration, are gaining momentum. Lenders, losing confidence in an office sector rebound and grappling with owners struggling to refinance under viable terms, are now triggering a wave of forced sales.
Holly MacDonald-Korth, CEO of KDM Financial, highlights a growing trend of owners relinquishing properties, particularly recent buyers whose equity has been eroded by market downturns. “We’re definitely seeing owners want to give up the properties, especially ones that were recently purchased, where their equity has likely been wiped out,” she said in a report by Bisnow. National Bureau of Economic Research estimates that nearly half of all office properties are now underwater on their loans.
The distress is evident in the banking sector, with major U.S. banks like JPMorgan Chase, Bank of America, Wells Fargo, and Citigroup collectively hiking their loss provisions by over 40 percent at the end of 2023. The CMBS (Commercial Mortgage-Backed Securities) market offers further transparency into the office sector’s struggles. Moody’s Analytics reported that $8.5 billion of CMBS office loans matured in 2023, and roughly $5.5 billion remained unpaid, forecasting a continuation of this trend into 2024.
Notable examples of distressed sales include properties in across the West Coast markets. In San Francisco, The Swig Company and SKS Real Estate Partners paid $61 million, or approximately $205 per square foot, to buy the 297,642-square-foot office building 350 California Street. The property, which was owned by San Francisco-based Union Bank (an entity of Mitsubishi UFJ Financial Group (MUFG)), had been on the market for three years, and the pricing guidance on the property when it hit the market in July of 2020 was $250 million, or roughly $840 per square foot.
Similarly, in Los Angeles, Aon Center, a 1.1 million-square-foot office tower at 707 Wilshire Boulevard, sold recently for $147.8 million, roughly $134 per square foot. The seller, San Francisco-based Shorenstein, purchased the property in October 2014 for $268,520,000, or just over $244 per square foot.
The shift towards short sales represents a pragmatic approach by borrowers and lenders to salvage capital. However, it also signifies a recognition of the office sector’s slower-than-anticipated recovery. Kastle Systems’ Back To Work Barometer indicates office occupancy remains significantly below pre-pandemic levels.
The market’s transformation is most acutely felt in non-performing areas, where the option to “pretend and extend” is increasingly untenable. This has led to a dichotomy where Class-A properties in performing markets still find amenable lending conditions, while others face stark realities.
Private equity, expected to be a major player in 2024, is poised to capitalize on these distressed assets. KDM Financial, for instance, has initiated a $350 million fund targeting multifamily bridge loans and distressed properties, including office spaces.
As the Federal Reserve’s interest rate hikes have led to a significant fall in office property values, the market braces for a potential 40-70 percent overall devaluation. This recalibration is closing the bid-ask gap, bringing a somber but necessary clarity to the sector.
