Stock Markets
Daily Stock Markets News

Office space downturn not likely to drag lenders down

Denver and the country as a whole are seeing very high levels of new apartment construction. Lenders have absorbed a glut in the office market, but they may not be able to handle an apartment glut. The verdict is out on whether tenants will be there to fill all the units. (Photo by Hyoung Chang/The Denver Post)

Investment in commercial real estate is at its lowest levels since 2013, office buildings are selling at steep discounts, and commercial construction is slowing dramatically, aside from apartments.

Lenders and the larger economy should be able to weather the real estate downturn, provided multi-family doesn’t follow down the same path that office space has, according to a leading commercial real estate economist.

“It is a period of pause in real estate, but no doom loop is at play,” said Richard Barkham, global chief economist with CBRE, the world’s largest commercial real estate services and investment firm, during a mid-year update for the National Association of Real Estate Editors in Austin on June 19.

Tenants are now requiring only 60% to 70% of the office space that they needed in 2019 because of the shift toward remote work that accelerated during the pandemic. Although more companies want staff to return to the office, it typically is only for a few days a week, reducing the amount of overall space needed.

“I expect that by 2025 we will have a 20% vacancy rate and not enough space,” Barkham predicted.

How is that possible? The office vacancy rate nationally was 17.5% and metro Denver’s rate was 23% at the end of May, according to Commercial Edge.

With abundant space available and lease rates falling, tenants are shifting toward higher quality Class A space, represented primarily in buildings constructed after 2010. Newer buildings are still seeing net positive absorption, meaning they are filling space, while older buildings are continuing to empty.

Barkham said new office construction is slowing sharply given the difficult market. At the end of May, there were 83.8 million square feet of office space under construction representing 1.2% of the existing stock, according to a report from Commercial Edge.

That number includes about 2.12 million square feet in Denver, with nearly a third of that coming in a single project, 1900 Lawrence St.,  a 720,000-square-foot building near the old Greyhound bus station, which is expected to open soon.

Riverside Investment & Development Co., along with Convexity Properties and Canyon Partners Real Estate, are the developers behind Denver’s largest office project in 40 years. Their argument for building the 30-story tower in an otherwise glutted market is precisely the one Barkham lays out — more high-end space is needed to lure workers back to the office.

Once the current pipeline is built out, Barkham argues the strategy will shift to rehabbing slightly older buildings. A separate CBRE study found that only 10% of office space is “prime,” or the kind that tenants currently desire.

“The game will be converting Class B space to what people want,” he said.

Through the first five months of the year, the U.S. office market has had $10.2 billion in transactions, with an average price per square foot of $165, according to CommercialEdge. In metro Denver, there have been $99 million in sales this year, at an average price of $103 a square foot, the lowest among the major Western cities.

A little more than $900 billion in debt tied to commercial real estate is coming due this year and needs to be refinanced. Next year that total drops below $600 billion and the year after to around $450 billion.

Large banks have built up their reserves to cope with potential losses, and while some smaller regional banks may still fail, it likely won’t trigger a larger financial crisis.

Right now, it looks like the banking system can handle the drop in demand for office space and the defaults that have resulted. But add in a double-whammy of a glut in apartment construction, and the story could change.

“If we get a similar drop in multi-family, we have a different situation,” Barkham said.

But how likely is that to happen? Elevated interest rates are leaving more would-be homebuyers renting rather than owning. The typical new mortgage payment in the U.S. is $3,153 a month, compared to an effective monthly rent of $2,163, according to CBRE.

That means more absorption, or people moving into new and vacant apartments once they hit the market. But the market’s ability to continue to fill new apartments will be tested in 2024 and 2025 as even more supply comes online.

The wildcard is how much demand exists to fill high levels of completions in the coming months, and if a glut emerges, how much will rents fall and what will…

Read More: Office space downturn not likely to drag lenders down

Notify of
Inline Feedbacks
View all comments

Get more stuff like this
in your inbox

Subscribe to our mailing list and get interesting stuff and updates to your email inbox.

Thank you for subscribing.

Something went wrong.