Assessing Lenders' Perspectives on the Present State of the US Office Market

In recent years, the challenges surrounding office space have become a recurring theme within the US commercial market, and this trend seems poised to continue as lenders remain cautious about the sector's prospects.

According to Alex Horn, managing partner and founder of private lender BridgeInvest, the current state of the office space is characterized by an imbalance in risk and return, a situation he describes as "asymmetric." He emphasizes that there is an oversupply of office space relative to the actual demand, a phenomenon exacerbated by the widespread adoption of remote work during the COVID-19 pandemic.

Horn predicts that this trend may persist for some time, leading lenders to adopt a cautious "wait-and-see" approach rather than committing capital prematurely. He believes that the United States is undergoing a shift in office usage habits, which will necessitate a period of adjustment and right-sizing over the next few years.

As a lender operating in this environment, Horn stresses the importance of carefully assessing the risk-return profile of office-related investments. He warns that investing in office properties carries the potential risk of financing assets that could become functionally obsolete, potentially jeopardizing the repayment of loans.

Despite these challenges, there are still opportunities for savvy buyers in the office space. Horn suggests that buyers willing to take calculated risks and capitalize on market downturns could find opportunities to acquire office properties at significant discounts. By underwriting to account for potential market disruptions, buyers may still realize fair value for their investments, even in a climate where a substantial portion of office supply may need to be reevaluated or repurposed.

"There are many individuals who see the potential in acquiring these properties without leveraging capital, holding onto them, and eventually profiting," he remarked.

However, while there is a plethora of buyers willing to take risks in the office space, determining whether such investments are prudent is a far more challenging task for lenders, he noted.

The outlook for the office market remains bleak, with Colliers offering a somber assessment for 2024 in its Q4 report. It noted that the sector had entered the previous year on shaky ground and showed little sign of improvement.

In 2023, office vacancy rates soared to 16.9%, surpassing levels seen during the 2007-08 financial crisis, despite growing optimism in the broader economy. This stagnation is attributed in part to the slow return of employees to physical office spaces. Despite CEOs' desires, the transition back to onsite work has been gradual, with most companies adopting hybrid models that allow for a minimum of three days in the office per week. Tight labor markets have empowered employees, making it challenging for CEOs to mandate more office days.

Downtown class A office rents declined by 1% in Q4 2023, reaching $53.55 per square foot per year, while suburban class A rents saw a 2.1% increase, reaching $35.15.

According to the report, many major tenants are expected to reduce office space by 20% to 30% in 2024, leading to further increases in vacancy rates, particularly for older properties, and downward pressure on lease rates.

Additionally, a looming $2.8 trillion in loans across various asset classes due by 2028 is expected to exacerbate distress in the market, forcing borrowers to decide between injecting more capital into their assets or relinquishing ownership.