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Weekly Market Report - August 14, 2023

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Generous tenant-improvement packages left cash flows thin when remote work and higher interest rates hit


Offices have underperformed in the US since 2008, partly due to the increasing costs of free rent and tenant improvement allowances. The sector had been struggling with disappointing returns for a decade before Covid hit. Offices in the country's 20 largest central business districts saw returns underperform in all but two years since 2008, partly due to the outsized gains seen in areas like industrial and multifamily properties. Office owners started dangling more sweeteners to lure companies to their buildings, leading to more frequent office relocations. Tenants wanted more flexibility and highly-amenitized spaces, leading to office capital expenditure requirements increasing faster than rents. The firm, like PGIM, decided to reduce its focus on offices, which made up roughly 60% of its portfolio in 2007. The significant costs to a building's operations can take three to five years into a lease before a landlord starts to make money on the deal. Tenant allowances have increased from about $67.50 in 2019 to more than $95 at the start of 2023, while free rent has gone from 7 months to more than 10. With interest rates going up, it's going to cost even more to write those TI checks, making it more expensive for landlords to give these allowances.



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Firms are raising billions of dollars for funds to target assets with slumping values.


Wall Street firms are raising billions of dollars to acquire office buildings, apartments, and other troubled commercial real estate, seeking to scoop up properties at a fraction of the price investors paid a few years ago. Cohen & Steers, Goldman Sachs, EQT Exeter, and BGO are among the prominent names raising billions of dollars for funds to target distressed assets and other real estate with slumping values. The new funds are seeking to capitalize on one of the most troubled commercial-property markets in decades, with values nosedived since interest rates spiked last year, driving up borrowing costs in the highly leveraged business. The office market, one of the largest sectors, has also been clobbered by a sluggish return-to-office rate, sending vacancy rates soaring. Apartment buildings, an investor haven in the past, look vulnerable as owners try to refinance at much higher rates.


Mall owners are contending with steep value declines, some of more than 70% over the past few years. The capitulation marks a new phase in the commercial real-estate upheaval, as more beleaguered property owners turn over properties to lenders or decide to take what they can get, rather than hold out hope for an eventual recovery. This wave of fundraising is the latest sign that sales activity is expected to increase as more sellers yield on price. Cohen & Steers is aiming to raise more than $2.5 billion in a new nontraded real-estate investment trust. Commercial-property values already have fallen about 10 to 15 percentage points from their peaks in the third quarter last year, and might fall a total of 20 to 25 percentage points. The volume of distressed commercial real estate grew by $8 billion in the second quarter, reflecting the rise in cases where the owners defaulted or lenders foreclosed.



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CBRE $7 B

Newmark $2.34 B

JLL $2.2 B

Colliers $2.1 B

Cushman & Wakefield $3.2 B


Interest rates and frozen transaction markets have led to significant losses for public brokerages, with many reporting drops in revenues in their second-quarter results. Profits have almost disappeared relative to the second quarter of 2022, and many firms have lowered their outlooks for the rest of 2023. The focus is on when the market will turn a corner, with many expecting it towards the end of this year. The gulf between buyers and sellers remains wide, meaning transactions are sparse. In the Americas, property sales revenue fell 49% more than expected, reflecting limited credit availability and the gap between buyer and seller expectations. Newmark CFO Mike Rispoli pointed to a 63% drop in U.S. investment sales and a 52% fall in industrywide loan origination. CBRE, JLL, Cushman & Wakefield, Colliers, and Newmark reported drops in revenue, while Colliers posted a loss. However, all firms reported year-over-year increases in services such as property, facilities, and investment management, reflecting a strategic shift among the biggest brokerages to even out their financial results when the economy slows.



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If you want people to come back to the office, give them a good reason.


Amazon sent emails to employees who were not following the company's return-to-the-office policy, which requires them to be in the office at least three days per week. Some of the emails were sent to employees who claimed to be following the policy, according to Insider. This raises concerns about employee dissatisfaction and potential "voluntary termination." Amazon has faced employee pushback over the policy, with some offices displaying protests. In some cases, Amazon requires employees to relocate to a central office and spend at least three days per week at that office. Amazon responded to employees who were concerned they received the email in error, stating that the email was sent to employees who have badged in fewer than three days a week for five or more of the past eight weeks, have not badged in three days a week for three or more of the past four weeks, and their building has been ready eight weeks or more. If there is confusion about how employees are complying, it's the responsibility of the manager to make sure it's clear. If employees aren't meeting expectations, it's important to create and manage expectations. If employees feel they're not meeting expectations, they should be aware of their situation and take appropriate action.



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As offices continue to empty across the nation, three new leases push vacancy rate below 10 percent in the 50-story tower


Stefan Soloviev, the heir to Sheldon Solow's real estate empire, predicted he would soon fill the office building at 9 West 57th Street, despite the soft market. Three leases signed last week have brought him closer to that goal, pushing the building's occupancy rate over 90%. Soloviev Group is seeing a dramatic uptick in commercial leasing activity at 9W, with companies such as Mousse Partners, Pointstate Capital, and Panco Management signing leases. The sloped skyscraper, built in 1974, has an air of exclusivity but a vacancy rate hovered near 50% under Solow, who preferred empty space over lower rents. Despite the leases, New York's office market remains challenged due to work-from-home policies during the pandemic lockdown. The office occupancy rate 9 West 57th St was just 48 percent the week of July 26, according to Kastle Systems' analysis of the number of times employees used Kastle fobs and keycards to access their buildings.



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Company admits “substantial doubt” over future; next 12 months will decide fate


WeWork has acknowledged substantial doubt about its ability to continue operating due to high membership cancellations and a shortage of cash. The company is focusing on cutting expenses, renegotiating lease terms, growing membership, and raising new capital. Interim CEO David Tolley blames "excess supply in commercial real estate, increasing competition in flexible space, and macroeconomic volatility" for the decline in memberships. The company's stock price fell below 20 cents per share in after-hours trading, down from a high of over $13 shortly after its public in October 2021. WeWork has lost a staggering $11.4 billion since 2020, and the situation complicates its efforts to remain listed on the New York Stock Exchange. WeWork's creditworthiness was downgraded following the restructuring, as ratings agency S&P Global lacked confidence in the company's ability to make good on its new financial commitments. WeWork's board is searching for Mathrani's permanent replacement, while Tolley serves as interim CEO. WeWork's collapse from a $47 billion private-owned company to one struggling to survive has left it without a profit.



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The Durst Organization is suing Bank of America and law firm Akin Gump Strauss Hauer & Feld, both tenants at One Bryant Park, to prevent them from doing a sublease deal together. The complaint, filed in New York County Supreme Court, stems from Akin Gump's plan to sublease one of its floors to Bank of America. Durst claims the agreement violates the terms of both leases. Akin, which leased 200K SF across six floors in 2006 and renewed for 280K in 2019, asked Durst in June for permission to sublease the 46th floor of the building to BOA. Durst rejected the request last month, arguing that the law firm's original lease prevents it from subleasing to any other tenant in the building if the landlord has "comparable space" now or within six months. The lease does not allow the tenant to rent space to a party with which the landlord is actively negotiating. BOA responded the same day, Durst says, saying the rejection was "improper" and that the landlord has an obligation under its lease with Akin to allow the sublease to go ahead. The bank claims it is not in any negotiations with the landlord. Durst is asking the court to rule that it is within its rights to reject the request and wants BOA and Akin to pay its legal fees. The exchange of responses amounts to irreconcilable differences it seeks the court to resolve.

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Blackstone, KKR arms didn’t issue any loans in the first half of 2023


Commercial lenders are facing a decline in new loans due to the rise of bad loans. Blackstone Mortgage Trust and KKR Real Estate Finance Trust did not issue any loans during the first half of the year, while Starwood Property Trust pulled back significantly from commercial loan originations. Mortgage REITs typically issue $10 billion in loans each quarter, and commercial and multifamily mortgage lending is expected to decline 38% year-over-year to $504 billion in 2023. Lenders are wary of the ongoing turmoil in commercial real estate, exacerbated by rising interest rates. When mortgage REITs pull back, commercial landlords may need to raise equity to refinance maturing loans. Insurance companies and nonbank lenders can fill the void left by mortgage REITs, and some commercial mortgage lenders are accumulating capital for future opportunities.



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Empire State Development is leasing five full floors at Durst Organization's 655 Third Ave. office tower, a significant boost for the city's muted office market. The deal is for 117K SF, and the agency will take space on the second through sixth floors of the 30-story building. The economic development agency plans to move its New York City headquarters down the street from Rudder Property Group's 633 Third Ave., where it leases roughly the same amount of space. The lease is one of the largest relocations in Midtown so far this year, and it was the second-largest lease in the city last month. Midtown's office availability rate was flat at 16% in July, with 949K SF of deals signed, a 50% year-over-year decline and a 20% dip from June. The city's overall availability rate stood at 17.8%, an all-time high. Landlords have had to move aggressively to secure tenants, and Durst sued two of its top tenants, Bank of America and law firm Akin Gump Strauss Hauer & Feld, to stop them from doing a sublease deal together at the building.

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