Analysis: U.S. Office Real Estate Market Shows Signs of Bottoming After Significant Discount Sales

By Matt Tracy and Shankar Ramakrishnan

The struggling U.S. office property market may be nearing its low point, analysts have indicated, citing a spate of sales for distressed properties at significant discounts in recent months that have begun to establish new pricing benchmarks.

The office property sector has faced substantial challenges since the pandemic, exacerbated by rising interest rates and a shift to remote work. According to the RCA Commercial Property Price Index, prices for office buildings decreased by 12.4% year-over-year as of the second quarter, fueling speculation about when the market will stabilize.

Stephen Buschbom, research director at industry analysis firm Trepp, remarked, "Peak distress is fully behind us," emphasizing the importance of more transactions to clarify pricing within the industry. He noted, "We still have price discovery left. An increase in transaction volume will mean that’s becoming more palatable for those holders."

Throughout 2023 and into early 2024, many developers and lenders opted to restructure maturing loans or postpone sales to avoid significant losses. Pre-COVID-19, office sales in the U.S. averaged around $35 billion per quarter; however, as property values dropped due to ongoing vacancies and elevated operating costs, this figure shrank to an average of $13.4 billion per quarter in 2023.

Yet, some analysts are detecting a resurgence in sales of distressed properties. Kevin Fagan, head of Commercial Real Estate Economic Analysis at Moody’s, noted that there are emerging indicators of market stabilization, as savvy property owners sell at considerable discounts to their original purchase prices, helping to create some indicative pricing for office assets.

Since the conclusion of the first quarter, seven office properties have been sold at discounts exceeding $100 million, a notable increase compared to just one in the first quarter and two for the entirety of 2023, according to Moody’s August report based on public records. Among these transactions was a Midtown Manhattan office building, which sold for a 97% discount from its original price, reflecting a loss of $276.5 million.

Another example highlighted included 1740 Broadway, which changed hands at a $416 million loss compared to its previous sale price. Investors also faced losses on AAA-rated bonds associated with the property, marking the first such occurrence since 2008.

With no clear pricing benchmark, many property owners have hesitated to sell, leading to a misalignment of pricing expectations. Instead, they have opted to prolong or refinance existing loans in anticipation of a period marked by lower interest rates and improved property retention prospects.

The real estate sector is contending with a dual challenge of high vacancy rates and declining revenues, complicating efforts for property owners to meet interest obligations on existing loans. Even with potential rate cuts, around 72% of nearly $19 billion in maturing loans over the next year could encounter refinancing difficulties, as owners may need to raise substantial equity.

Additionally, approximately one-third of loans maturing in 2024 have either failed to resolve or refinance on time, according to CRED iQ data. As Ryan Riel, chief lending officer at EagleBank, noted, significant loan balances in the broader market may lead to further sales transactions toward the end of the year and into early next year.

The Federal Reserve recently made its first interest rate reduction since 2022, cutting rates by 50 basis points in September and hinting at future cuts. While this reduction might signal hope, experts believe that a revival in the commercial real estate market would necessitate rate cuts of 300-400 basis points to offset the steep decline in property valuations.

An example of proactive lending includes Parkview Financial, which plans to auction $300 million in loans secured by multifamily and office properties in New York, New Jersey, and Connecticut. Parkview’s CEO reported receiving multiple bids for four of those loans, with plans to use the proceeds to issue new loans.

Such sales are creating opportunities, observes Keerthi Raghavan of Waterfall Asset Management, which has invested almost $2 billion over the past year in bonds and loans sold at steep discounts. He cautioned that the fundamental issues facing the market won’t vanish quickly and that many commercial real estate assets will still need to be divested or resolved, maintaining elevated supply levels.