Obsolescence Equals Opportunity_final (002)

Putting the Challenge into Context: The entire office market doesn’t need to be overhauled to move toward greater health, but targeted improvements or repurposing by investors, municipalities and occupiers could pay dividends. Possibilities include upgrading office stock to be more competitive for today’s occupier needs or shifting some portion of office space towards other in-demand uses such as multifamily, life sciences, health care or mixed-use properties. Moreover, as vacancy rises and property income weakens, many obsolete office properties are likely to encounter greater difficulty in meeting their debt obligations, which will place greater emphasis and likelihood for such assets to be reimagined. Potential Loan Distress is featured in Chart 14 and demonstrates that $40 billion in outstanding office loans currently face some form of trouble or distress, representing 1.7% of total outstanding loans. 16 Loan trouble also varies considerably by market, as depicted in Chart 15, which features Potential Loan Distress by Market. For markets with greater than $10 billion in loans outstanding (capturing 27 markets nationwide), the range in troubled loans varies from 0.4% for Boston to nearly 5% for Orlando. 17 Most of the higher-risk markets are non-gateway markets, confirming that obsolete buildings are not just limited to the gateway markets which have seen outflows of tenants to more affordable Sunbelt metros. In addition to the difficulty in meeting debt obligations, the office sector is also facing a wave of oncoming debt maturities representing more than $130 billion over the next two years (Chart 16). Over the same period, 20% of all office loans maturing are those with shorter-term debt structure (0-3 years). 18 Many of those recently

CHART 14: DISTRESSED LOAN PERFORMANCE BY SECTOR by outstanding loan amount ($B USD)

$60

6%

4.7%

$50

5%

3.9%

$40

4%

$30

3%

$20 Billions

2%

2.2%

1.7% 1.7%

$10

1%

$0

0%

Hotel Industrial Retail Apartment O ce

Total Distressed Distress Share of Total Loans Outstanding (rhs)

Source: RCA; Cushman & Wakefield Research “Trouble” includes Lender REO, Potentially Troubled and Troubled Loan Performance Status.

originated loans haven’t had enough time to accrue value appreciation, and they are also facing value losses due to both performance and cap rate escalation throughout the market. Therefore, depending on asset condition and performance, refinancing might not be an option, particularly given the degree to which debt costs have risen. Collectively, mounting vacancy, loan distress and oncoming loan maturities will force many owners to evaluate their assets’ strategies.

16 Source RCA and Cushman & Wakefield Research 17 Source RCA and Cushman & Wakefield Research 18 Source RCA and Cushman & Wakefield Research

22 | OBSOLESCENCE EQUALS OPPORTUNITY