As receivers, we’ve all seen a variety of financial and economic factors over the years that have created market distress and demand for our services. Many of us lived through the Savings and Loan Crisis in the late 1980s and early 1990s, the Dot Com market collapse in the early 2000s, the Great Recession, and most recently, the COVID-19 pandemic.
Yet few have been as poised for a perfect storm of problems as the commercial office sector is today. Office real estate has been hit hard by a number of known elements: a widespread shift to remote working and “work from home” arrangements dictated by the pandemic; a period of historically low interest rates, followed by a fast- rising interest rate environment; and more than a trillion dollars in commercial loans coming due in the next three years. The commercial office sector has been a slow- motion car crash we’ve all seen coming, but has been impossible to avoid.
With this backdrop comes a very strong demand for receivers and problem resolution expertise — an uptick we are already starting to see in mid-2023.
The Perfect Storm
The impending doom for office real estate is caused by a confluence of the above factors, all of which are escalating in tandem.
First, there was a major flight from city centers at the onset of the Covid-19 pandemic, and the trend continued as many employers shifted permanently to remote-work and hybrid office policies.
In Q1 2023, this phenomenon led to vacancy rates in excess of 20% on average for office real estate, according to JLL’s Office Outlook report for the first quarter of 2023. The “impact is felt primarily among older, commodity assets,” JLL noted. The situation is more pressing in some cities; in Dallas, for example, the vacancy rate topped 25% in the first quarter, likewise the Houston, New Jersey, and San Francisco markets also experienced vacancy rates over 25%.
Net absorption, similarly, continues to struggle in most markets, with the worst cases being San Francisco and Boston. While there are several exceptions in metro areas including Nashville, Charlotte, and Miami the overall picture is bleak.
“Despite continued office-using job growth, Q1 saw 16.5 million sq. ft. of negative net absorption—the weakest quarter for office demand in two years—due to recession fears and hybrid work arrangements,” writes CBRE in its Q1 U.S. Office Figures report, published in May.
Further, as the number of interest-only commercial loans made in recent years increased steadily, borrowers are beginning to face significant payments in today’s rapidly rising interest rate environment.
With many indicators pointing to distress ahead, Colliers International sums up the situation in the North American commercial office market in its June 2023 “Insights and Outlook: Office” report:
“The softening of key U.S. office market fundamentals accelerated in the first quarter of 2023. Net absorption remained negative, occupancy losses increased, vacancy rose at a faster pace, and available sublease space hit a new record high.”
Having served many roles as both a receiver and as a principal developer of mixed-use real estate including office properties for the past three decades, DWC anticipates there will be continued trouble in major cities and elsewhere for office buildings.
From extend-and-pretend activity during the Great Recession to the pandemic-era forbearance policies and massive amounts of liquidity in between, we now have a new reality: as interest rates and cap rates rise, values fall. Those servicing the billions of dollars in commercial real estate loans aren’t going to extend-and-pretend any longer, particularly for B and C Class properties. Those companies that are signing new leases today desire newly built or newly renovated spaces, which they can demand given the state of today’s market. With values plummeting as a result of these factors, it will be an environment ripe for receivers, evidenced by several recent projects that already have receivers in place.
The Role of the Receiver in Today’s Office Market
Those of us well known in the commercial real estate sector will be very active in the months ahead as we step into these situations to act as a neutral party to preserve value. We are already seeing such assignments in the market, notably a recent default in Los Angeles: Brookfield’s Gas Company Tower at 555 West 5th Street, which went into receivership in April following the borrower’s default on a $350 million commercial loan and failure to pay a property tax advance.
Management and operations.
As receivers, there are several measures we will take to help lenders and owners in the many distress scenarios we will encounter like this one. In most cases, we will bring in new management and leasing operations, and we will oversee rent collection when a borrower is no longer able — or cannot be trusted — to take care of and look out for the best interest of the asset. In others, we will also oversee the sale of the property through a receivership sale. By employing the services of a receiver and neutral third-party fiduciary, lenders are able to remain unencumbered and out of the chain of title — a strategy that is becoming increasingly common among lenders.
Partial construction. In some of these instances, we will also face incomplete construction, as was the case in Half Street, a partially completed 400,000 square foot office building with three levels of subgrade parking and ground floor retail in Washington, D.C. There, the receiver was tasked with preserving, protecting and eventually completing the construction of the collateral, including the settlement of numerous mechanics’ liens and claims on the property.
In yet another broken construction example, the partially-complete 268,000-square foot Opus East National Oceanic and Atmospheric Administration (NOAA) office and research facility was placed under receivership, and was in need of completion. In this case, the receiver was responsible for coordinating the construction, settling an existing GSA lease dispute and settling mechanics’ lien claims on the property.
In these “broken construction” scenarios, this might mean taking a number of steps, such as negotiating with contractors and subcontractors owed for work completed prior to the receivership; renewing and maintaining insurance policies; drying in, water-proofing and overseeing other measures to protect the existing structure; working with the court to allow for the receiver to sell the property; and marketing the property for sale, as well as navigating the receivership sale process through the court system.
In other instances, distressed properties may need environmental remediation due to hazards such as asbestos, or those that are introduced due to mismanagement. In these cases, receivers are especially important so as to protect the lender from being involved in the chain of title and/or becoming responsible directly for the abatement.
The Future Ahead
In today’s commercial market, conditions will get worse before they get better. Newer large scale office buildings typically aren’t candidates for repositioning because of their infrastructure, and today’s regulations won’t allow for cost-effective repurposing or new
permitting. While we may see changes long-term in the viability of these types of solutions, as of today receivers will be a critical element toward resolution. Office real estate owners and lenders moving through these tumultuous times would do well to consider receivers as a tool with which to preserve value.
*Douglas Wilson is CEO and Chairman of DWC *Ryan Baker is Vice President of DWC
Douglas Wilson Companies is based in San Diego, CA with offices in Orange County, Los Angeles and throughout the U.S. The company provides services in real estate development or completion, maximizing asset value in receiverships, advisory consulting, and as a specialized broker.