source: Flickr: https://www.flickr.com/photos/drljohnson/4280266430/
Some time ago I raised the issue in one Tip as to the concern with the huge increase in vacancy rates for office buildings, mainly caused by reduced demand for such space.
Office buildings have continued to decline in value in almost all major cities within the US; Denver is no exception to this trend.
The combination of Covid19, coupled with the movement toward working at a distance, working from home, working on flexible days and times, less demand for space, lower rental rates, and related issues have compounded the concern with the rising vacancy rates.
All reasonable investors in income producing real estate, such as offices, are aware that as net operating income falls, the value of the investment declines as well. Thus, when office rentals decline, the value of the office building declines. When the office building investment decreases in value, the ability to refinance the building is also impacted. Assume an office building was valued, based on the income produced from the building and its potential appreciation, at $25 million dollars, but due to such decrease in income (caused by lower rents and vacancies), the current appraised value of the building is now $15 million. In such a setting, the ability to obtain refinancing on the building is now much more difficult. That is, if a lender was willing to loan 70% of the value of the building some years ago (say 70% of the $25 million, or a loan of $17.5 million) when the structure was valued at $25 million, using this same ratio today of 70%, the amount that would be loaned would be $10.5 million. This also assumes lenders would be willing to consider a loan in the market, today, on office buildings. Also, the lender might now be willing to only loan at a lower % ratio, such as 65% of the current value.
The above setting in the example is where many office building owners/investors are sitting today. They are having trouble with refinancing. If they can obtain from a lender a new loan, such loan will require the investors to invest more funds when the building is refinanced, given the above scenario. If the existing loan in the above example is at $17.5 million that must be paid, but a new loan can only be obtained, at best, for $10.5 million, the $7 million difference between paying off the loan of $17.5 million and obtaining a new loan of $10.5 million, will produce a good deal of financial pressure on the investors.
What is happening today with many investors is the inability (or lack of desire) to fund the extra monies needed, as illustrated above, results in the loan moving to a default position. Foreclosures and other arrangements are then made to meet the requirements of the note holder, such as the lender, to resolve the needed payoff.
The additional concerns with increased interest rates, more loan charges, a lack of interested buyers for such office buildings, and other negative considerations is creating a difficult situation for lenders, investors, tenants, property owners in the area around the subject office building, employees within the building, insurance companies, governments relying on the property taxes, sales taxes, etc. relative to the building, and others impacted by the defaults occurring on loans involving office structures.
Many of the above noted folks are addressing these issues with loan defaults.
The office dilemma will continue to be an enigma for many years to come.
However, many groups are attempting to consider alternatives that might eliminate or reduce the damage that is being felt by those involved in this setting.
There will be many more groups addressing this conundrum.
One event that might be of interest to many in the above setting is the examination in detail of this issue being undertaken at the University of Denver, Daniels College, Burns School. The Burns School has developed a Major Event known as the Educated Opinions—Office Building Conundrum. For most information on this coming Event, see the following:
University of Denver Educated Opinions 2024
Event date: 9/25/2024
Location: Republic Plaza, Denver, Co.
Partial Agenda: Economic Forecast as to office space rental
Fellows’ White Paper
Willy Walker Podcast
Mayor Mike Johnston
And much more!
For More Information: David Thomson 720 300 5500
Closing thought: The Office Building crisis is no small issue. It will take years to resolve the current status of defaults, lower occupancy, and lower rents.
Professor Mark Lee Levine, University of Denver
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