Core Texts: Office Values Dip, Amenities Spur Gains

Discover more about the office market’s projected performance and amenities’ impacts on rent and occupancy, plus more insights in this week’s Core Texts.

1. Office Values Dip And Face A Long Recovery 📉

💡 What you need to know: Fitch Ratings presented an ominous forecast for office property valuations on Wednesday, projecting further declines and a recovery timeline exceeding that of the 2008 Global Financial Crisis (GFC). The firm’s analysis, supported by data from Green Street Advisors’ U.S. Commercial Property Price Index, shows a current 35% decline in office values since the 2020 downturn, with anticipations of further drops surpassing the 47% decrease observed post-GFC. This downturn has persisted for four years, in stark contrast to the 87-month recovery period following the 2008 crash. Unlike market conditions during the post-GFC era, where low interest rates and a gradual increase in demand facilitated recovery, current conditions – including a robust overall economy – do not forecast a similar rebound. 😥

Additionally, Fitch projects a significant rise in the CMBS office delinquency rate, foreseeing it to reach 9.9% in 2025, surpassing post-GFC peaks. The duration for resolving defaulted CMBS loans has also elongated, indicating a protracted period of financial adjustment for the sector. The median implied capitalization rate for office properties has escalated to its highest level since 2000, reflecting increased risk and lowered valuation expectations.

⚡ Why it’s important: Fitch Ratings’ report paints a scenario of enduring valuation impairments and escalated CMBS loan losses nationally despite an otherwise strong economy. Yet, there’s reason to believe that specific submarkets and targeted portfolios can navigate the downturn with relative resilience. Recent New York City office occupancy data puts attendance at nearly 80% of its pre-pandemic levels. This comes as the city has seen a significant rebound in foot traffic, and provides some hope that NYC offices will experience a more expedited recovery path. This outlook is supported by the market’s rating assessments of NYC-centric REITs like ESRT – as we covered in Core Texts earlier this month – and JP Morgan, which have outperformed expectations in recent months. 📈

This contrast offers a nuanced perspective, indicating that while the overall office real estate market faces significant challenges, regional dynamics, such as those in New York, may offer pockets of hope and resilience. Even amid widespread downturns, strategic advantages and positive trends in specific markets can provide a foundation for optimism and a blueprint for adaptation in the face of overarching market adversities.

2. Amenities Spur Huge Rent & Occupancy Gains 🏰

💡 What you need to know: According to a new report produced by JLL, the pandemic-induced shift towards remote and hybrid work models has sparked a competitive drive among office buildings to offer distinctive amenities. Notably, certain amenities are linked with higher rent premiums: buildings featuring a roof or sky terrace command a 5.2% rent premium over Class-A buildings within the same submarket. Courtyards with outdoor seating, or LEED certification also boost rents by 3.5% and 2.8%, respectively. The report highlights the importance of the quality and uniqueness of amenities in achieving rent premiums, illustrating this with comparisons between basic and upgraded amenities, such as fitness centers with and without shower facilities, and the difference in rent premiums they can command.

⚡ Why it’s important: ️Amenities continue to play a critical role in attracting tenants, as they work to lure employees back to the office. The pursuit of amenities is not just about offering extra services; it’s a strategic approach to differentiate buildings and increase their competitive advantage. The report indicates that buildings with a comprehensive range of high-quality amenities have seen substantial absorption gains, contrasting sharply with the loss of occupancy in less amenitized urban Class-A products. 😎

However, the influence of amenities on occupancy rates and rent levels is nuanced, with factors like location, building age, and access to public transportation also playing crucial roles. Despite the allure of amenities, the broader market faces challenges, including a trend towards reduced office space and a national vacancy rate at a record high, suggesting that while amenities can enhance a property’s appeal, they are part of a complex set of variables influencing commercial real estate dynamics.