Loan defaults are a dangerous emerging trend

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David Baird has more than four decades of CRE experience. Image courtesy of Sperry CGA

The office sector is going through a phase of transformation, mainly due to the continued popularity of remote and flexible working models and the need for tenants to reassess the use of their office space. In addition, the current economic environment and high interest rates are adding fuel to the fire, pushing some lenders aside and forcing office owners to review and adapt their strategies.

“The new office loan market has dried up,” said David Baird, national director of institutional investments at Sperry CGA, a brokerage firm based in California. “Even with an infusion of new capital, lenders typically ‘stretch and fake’ or ‘slow and pray’ for the market to improve.”

Commercial Real Estate Executive asked Baird, who has more than 40 years of experience, to discuss the current dynamics in office lending and expand on his firm’s response to maturing debt.

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What are the main trends you see in the office sector today and how is Sperry Commercial responding?

Baird: The main trend we are seeing in commercial real estate today is the emergence of loan defaults based on maturity and high interest rates. Loan delinquencies continue to rise and are a dangerous emerging trend. Leading the race for the default table is the office market. As loans become due, office properties cannot generate enough revenue due to vacancies to support a new loan.

Lenders refuse to work with homeowners to refinance their loans without significant additional capital injected by the borrower. In response to this evolving market, which affects all commercial properties to varying degrees, Sperry Commercial assembled the Commercial Property Resolution Team, or “CPR”.

The team has the experience and depth to handle loan restructuring, governance, tendering and restructuring legal issues. Our team of experienced professionals has achieved exceptional success in restructuring borrowers’ loans. The Sperry CPR team gives borrowers options instead of just handing back the keys.

Where does the most stress come from for office landlords?

Baird: The office as a whole is most affected by current market conditions. Stress comes from a change in the work environment for office workers. The trend of working from home has led to an acceleration of office job vacancies. This may be a constant change that prompts office property owners to adjust to the phenomenon.

While some office markets have performed better than others, all office properties, regardless of their financial performance, still have to deal with loan maturity issues. Lenders are reluctant to lend to office properties without adding additional capital. Markets like San Francisco are the hardest hit because of the work-at-home problem in the tech sector. This scenario looks like a long-term problem until the market adjusts.

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Please tell us about a notable office deal you’ve been involved in recently. What makes this deal different?

Baird: A notable sale was a leaseback sale. The leaseback was only for one year on a 200,000 square foot building. This stands out because the San Francisco market has such huge vacancies… The sale was handled by Eastdil Secured. Office transactions are at record lows due to financial fundamentals. With cash flow dwindling and costs rising, the brokerage community is seeing a void of transactions.

How have the changing needs of tenants and landlords affected office value?

Baird: We are currently in a major demographic shift in the office. The evolution of working from home has led to large vacant offices. Tenants don’t need the space they used to. As vacancies and loan defaults rise, office assets can no longer service the debt. Values ​​are falling and lenders are reluctant to lend against office properties. The CPR team works with the lender to get a resolution and give homeowners options they may not have thought of.

Which types of commercial real estate have been least affected by current economic conditions?

Baird: In our experience, the property types least affected by current conditions appear to be industrial and multifamily. However, many contributors say there is much more disaster ahead, affecting most property types.

What should office landlords do while tenants determine their occupancy?

Baird: The market must adapt to the new reality of excessive office space. This can take years to achieve. Until this fix completes this phase, landlords need to get creative and reset their expectations. Flexible working hours and office requirements will bring employees back to the office workspace. Landlords will adapt by downsizing and renegotiating their loans to accommodate the new reality of fewer people occupying the space.

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