“Commercial real estate may get worse before it gets better,” Chris Ludeman, global president of capital markets at real estate services firm CBRE, said on a recent call analyzing current economic challenges.
Nationwide, about $1.5 trillion of commercial real estate debt is set to come due before the end of 2025. Landlords are going to be under pressure to pay off or refinance those loans. Office buildings with fewer tenants are worth less than ones that are full, putting the squeeze on owners.
A stable office market and its workers feeds other industries, boosting nearby retail and restaurants. When the values of commercial properties rise, so do their contributions to city, county and school tax rolls.
But the pain in national and Atlanta office real estate markets threatens to sink values, hurting tax collections that local governments rely on to provide services. Henry Lorber, an expert in distressed real estate with Henry Lorber and Associates, said office buildings that decline in value or go through foreclosure will have ripple effects on nearby properties, lowering their value in kind.
“I see a race to the bottom,” he said.
The Great Recession stretched from 2007 to 2009, but its aftershocks lasted years longer. Atlanta landmarks like Bank of America Plaza, the city’s tallest skyscraper, went into foreclosure. Several shimmering new office towers planned when the job market was strong sat vacant. Things got so bad that Buckhead boosters bought full-page color ads in the Wall Street Journal to entice condo buyers and employers to move into the affluent community to take advantage of the area’s overbuilding pain.
More than 10% of Atlanta’s office stock has a loan maturing in 2023, which research firm CommercialEdge found is among the largest proportions for major cities. Data firm Trepp reports that metro Atlanta’s office delinquency rate is about 7%, nearly triple the national rate.
However, the value of many of those loans pales in comparison to a larger market like New York City. Trepp data shows $625 million in office loans are set to mature this year in metro Atlanta, while that figure is $5.3 billion for the Big Apple.
Credit: Jason Getz / Jason.Getz@ajc.com
Credit: Jason Getz / Jason.Getz@ajc.com
More than a dozen real estate experts, analysts and large property owners told The Atlanta Journal-Constitution they expect turbulent times ahead for Atlanta’s office market, especially among older buildings in less attractive office districts, known in the industry as submarkets. However, many were optimistic that parts of Atlanta would be insulated against the potential pain to come.
Mark Toro, a developer who steered development of the landmark Avalon mixed-use project in Alpharetta, said the divide will widen between new offices in desirable locations and buildings that don’t draw demand in a post-pandemic world.
“They are suffering the double whammy of financial pressure and obsolescence,” Toro said.
‘A tsunami of events’
Atlanta’s harbinger of dour times for the office market may have come last September.
Six towers and the mall within Peachtree Center, a landmark downtown office and retail development, were returned to the lender in the largest foreclosure sale in Atlanta since the fallout of the Great Recession. A handful of other notable downtown properties, including the Sheraton Atlanta Hotel and the 10-acre Forge Atlanta mixed-use site, have since defaulted.
Eric Anderson, an attorney with Parker Hudson who specializes in problem loans, said it’s too soon to tell the extent of the distress to come. He said it’s likely that more office landlords will decide to dangle keys before their lenders rather than go through bankruptcy or toil away with a diminishing asset.
“The commercial real estate reckoning is coming,” Anderson said. “... But this isn’t going to catch anybody by surprise like it perhaps did in the ‘08 crash.”
Beyond downtown, cracks are emerging among suburban offices. Headlines in March over the potential foreclosure of a fully leased Alpharetta office building were a wake-up call to many owners of offices orbiting Atlanta.
The two-story, 105,000-square-foot office building at 3750 Brookside Park owned by OA Management, nearly went to auction on the Fulton County courthouse steps after its $11.9 million loan matured. But Steve Berman, a founder and partner at OA, said the sale was averted by last-minute negotiations with its lender, Renasant Bank.
Negotiations remain active, but Berman said the financial outlook for buildings like his is tight.
“Interest rates have more than doubled, tenant improvement costs have tripled and demand for office space has dropped significantly because of the pandemic,” Berman said, adding that his largest tenant is downsizing. “It’s a tsunami of events.”
In an attempt to stifle inflation, the Federal Reserve has aggressively raised interest rates 10 times over the past 14 months, most recently on May 3, from 5% to 5.25%.
Rates have increased 500 basis points since March 2022, affecting how much interest borrowers must pay on adjustable loans.
Lorber said he expects many landlords will struggle to make these steeper payments while grappling with office tenants who either aren’t willing to pay more in rent or who are downsizing to satisfy the work-from-home culture.
“You’re used to borrowing at 4%, but now you’re borrowing at 8%,” he said. “It’s a problem for your cash flow, because you cannot increase your rents accordingly that quickly.”
The average asking rent for office space in Atlanta was $30.40 per square foot at the end of March, according to CBRE data. That’s roughly a 4% increase from the first quarter of 2020, when the pandemic began.
Some submarkets have seen average rent prices increase more dramatically, such as west Midtown, the Central Perimeter and downtown, which is undergoing a massive revitalization campaign.
All eyes turned to the banking sector in March when Silicon Valley Bank went belly-up.
Since then, two more regional U.S. banks and Switzerland’s Credit Suisse collapsed, sparking immediate federal action to stop widespread bank runs. The chaos prompted CBRE to hold an impromptu March call to explore how instability in the banking sector could affect commercial real estate.
CBRE predicted a modest recession would be around the corner, which would likely lead to fewer financing options and flexibility for landlords looking to remain current with their payments or refinance their debt.
Hagan Dick, executive vice president on the Colliers Atlanta debt and equity team, agreed, telling the AJC, “The recent bank failures will likely add additional pressure to future lending capacity as banks seek to bolster their reserves.”
CBRE found that nationally, a tenth of office buildings accounted for 80% of increased office vacancy between 2020 and 2022 — which analysts say shows the worst-positioned buildings will bear the brunt of the pain. Older office buildings are often called Class B, while new spaces are coined Class A, or trophy.
Tom Traynor, CBRE’s vice president of debt and structure finance, said owners of older Class B office buildings must “be honest with the numbers.”
His advice to these owners: “It’s not going to be cheap to refinance. You’re going to have to infuse more equity in, and it’s going to be costly to keep those buildings full.”
‘Atlanta will not be immune’
Since the pandemic, companies big and small have been reassessing their office needs, leaving office builders and owners in purgatory.
Abe Schear, a partner in real estate and leasing practices for Arnall Golden Gregory, said office buildings that rely on one tenant are more at risk. Layoffs or profit downturns could drastically impact a company’s leasing plans.
“They stand at a greater risk of being wonderful one day and being in a big problem the next,” Schear said.
Abby Corbett, head of investor insights at real estate services firm Cushman & Wakefield, said a bevy of buildings are likely to become obsolete in the coming years. Nationwide, she expects roughly 330-million-square feet of offices — about the size of 254 Bank of America Plazas — will become vacant and outmoded by the end of the decade.
She said the same factors that make an office building undesirable also increase its risk of loan distress.
“If you’re a property that’s in a not-so-attractive submarket that tenants and employees don’t want to be in … if one of those properties has a loan maturing, it’s absolutely going to be more challenged in those conditions,” she said.
Her colleague David Smith, Cushman & Wakefield’s head of occupier insights, added that Atlanta’s continued population growth and low unemployment rate should help insulate its workplaces, especially for newer buildings in thriving submarkets. The city’s vacancy rate at the end of March was about 23%.
But he said a widespread disruption in the office market will leave few places unscathed.
“Atlanta will not be immune,” he said.