Vacancies in the Atlanta CBD are
greater than in the metro
greater than in the metro
area's suburban submarkets.
The improvement in economic and commercial property fundamentals may be too gradual for some office loans this year. Office rents have ticked upward and vacancies have ticked downward in many markets, but neither metric is on par with the pro formas that often were used to underwrite office CMBS at the market’s peak. There’s also the question of five-year leases that are due to expire this year.
Earlier in the recovery, hotels were seen as the problem child of commercial real estate. Now the lodging sector has rebounded strongly and it may be office’s turn for struggle. In January, theWall Street Journal ran a story titled “Trouble is Brewing for Office Market,” profiling some specific large properties that are facing this combination of maturing debt, rolling leases and spotty recovery in fundamentals. More generally, Fitch Ratings said earlier this month that late-pays on CMBS loans backed by office assets have reached an all-time high, and last month Fitch gave office CMBS a negative outlook for 2012, the only property sector to achieve this dubious distinction.
In a sampling of 11 specially-serviced office loans provided by Trepp to Distressed Asset Investments, all but one—Golden Triangle I&II in Greenbelt, MD, which transferred to special servicing this past December—originated during the 2005-2007 market peak. Largest of the loans by unpaid balance is $65.6 million on One Main Place, a one-million-square-foot office property in Dallas that was 34% vacant as of this past October. At that time, Fitch downgraded seven classes of circa-’05 GE Commercial Mortgage Corp. pass-through certificates due mainly to specially serviced loans, including the one on One Main. Eight of the properties in Trepp’s sample are REO or in foreclosure. One Main Place, which transferred to special servicing in December 2009, is 90-plus days delinquent, while the Golden Triangle complex is 30 days past due.
Although delinquency among Fitch-rated office CMBS is still well shy of multifamily’s 12.77%, its current 7.30% delinquency rate is no longer the lowest. That honor now falls to retail, which also saw a marginally smaller basis-point increase in its delinquency rate between December 2011 and January of this year: 42 bps to 7.21% compared to the 46-bp rise seen in office. Hotel and industrial CMBS experienced smaller monthly increases, while multifamily’s 165-bp decline pulled down the delinquency rate overall for January, the sixth month in a row that CMBS late-pays have declined, according to Fitch.
Even so, say Fitch and other sources, not all office properties will face headwinds in 2012. During a seminar sponsored by the Real Estate Board Of New York earlier this month, John Sikaitis, SVP and director of office research at Jones Lang LaSalle, said the best-recovering US office markets are those with a concentration of technology and energy tenancies. For its part, Fitch is concerned mainly by suburban office space and properties in “struggling markets.” According to Integra Realty Resources, suburban markets in the Chicago, Las Vegas, Sacramento, Tulsa and Tampa metro areas average greater than 22.5% vacancy, while CBD offices in Vegas, Atlanta and Dallas average greater vacancy than their suburban counterparts.
Vegas and Atlanta both figure in IRR’s ranking of the top 10 office markets for distress, coming in at numbers three and eight, respectively. The top market for office distress as a percentage of 2001-2010 annual transaction volume is Detroit, followed by the Inland Empire, according to IRR, although the Motor City fares better than many other CBD markets in terms of the amount of time it will take for office fundamentals to stabilize. IRR figures that it will take the nation’s CBD markets an average of four to five years to stabilize, a range that dovetails with its projection for Detroit’s office fundamentals. By contrast, office fundamentals in Atlanta, Memphis, Northern New Jersey and Columbus, OH, among other markets, aren’t expected to achieve balance for 10 years or more.
Unlike the CBDs, where there was little new construction in recent years, the suburban markets have seen slight increases in supply. IRR says this negatively impacted the balance between supply and demand. “Additionally, the economy’s inability to create sustainable job growth appears to be impacting absorption expectations in the suburban office sector more than in the CBD office sector,” according to IRR’s Viewpoint 2012 report.
In an interview with the Seeking Alpha website earlier this month, Victor Calanog, head of research and economics at Reis Inc., predicted that the office sector will continue improving at a modest pace. He cited consensus forecast showing little hope for a ramping-up of job creation. “If we continue to proceed at a roughly 100,000- to 150,000-per-month pace in terms of job creation, it will continue to nudge office vacancies down, but not at a very fast rate,” Calanog told Seeking Alpha. Absorption in the sector will be positive, he said, but the total absorption across the span of 2012 will be equal to what we’d see during the course of a quarter in a more robust market.
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