Not all CRE assets are CBD office buildings, and not all CBD office properties are the same.
Problems facing some CBD office properties are clouding the commercial real estate landscape, according to experts attending the National Association of Real Estate Editors conference in Austin last week.
Jim Costello, chief economist at MSCI Real Assets, told reporters and spokespeople that central business district office building values have fallen 56 percent from their peak, but that's only a slice of the industry based on a limited number of transactions. “It's not healthy by any stretch of the imagination,” Costello said. “These assets are hurting and will continue to hurt, but that's not true for all commercial real estate types.”
Meanwhile, some sectors like apartments and industrial are faring much better, Costello said. “If you look at not just asset price movements but how the stock market is valuing these companies, you're already seeing a turnaround,” he explained.
Moreover, Costello said concerns about CBD office debt repayments have been generalized, casting doubt on all banks, including smaller ones that don't lend to large urban office properties. “So sometimes people in the banking industry take it in too broad a light and exaggerate the extent of this problem,” he said.
Flight to quality
On the panel that followed, several office owners argued that a distinction should be made between offices and more premium office properties: that is, while all office owners have an interest in absorption capacity and in bringing tenants back to the office, some are doing a better job than most others.
“The flight to quality is real,” said Brett Mertz, senior vice president of asset management at KBS Realty Advisors. “It's not necessarily a new concept. We believe there is momentum and it will continue to move forward.”
Mertz said that in some of the company's submarkets, the difference in vacancy rates between “tier 1” and non-tier 1 assets can be as much as 6%, and asking prices can be 45% higher for tier 1 properties.
Ace Roman, senior vice president and co-head of asset management at Granite Properties, agreed that location really matters these days. He noted that even older assets in mixed-use hot spots are benefiting from a flight to quality. Granite bought First Avenue Plaza, an '80s-vintage office complex in Denver's Cherry Creek neighborhood, in 2022. Since then, the company has boosted occupancy in the two buildings from 90% to 97% and raised rents by 20%, Roman said.
“The age of the building is important, but it's not everything,” Roman said.
The flight to quality isn't just limited to real estate, said Alex Hancock, national head of sales and leasing at Howard Hughes Holdings Inc. “It's also about quality amenities, quality buildings and quality landlords who can do the deal,” he said.
Hancock also stressed the importance of mixed-use environments: “Being able to offer tenants these 'little cities' is particularly powerful today,” he said.
So if premium space is so scarce, is new Class A development on the horizon? Not likely, says Roman. Developers would need to have 60% pre-lease commitments in place before approaching lenders, and even then, interest rates are at 9% to 10%, forcing them to charge rents that are currently unfeasible. “I think we'll see some of these factors converge, maybe in two, three or even four years, where it becomes reasonable to build, Class A rents rise and the debt market becomes a little more open to office.”
This article first appeared on Commercial Property Executive