Defaults and vacancies are on the rise at high-end office buildings, in the latest sign that remote work and rising interest rates are spreading pain to more corners of the commercial real-estate market.
For much of the pandemic, buildings in central locations that feature modern amenities fared better than their less-pricey peers. Some even were able to increase rents while older, cheaper buildings saw surging vacancy rates and plummeting values. Now, these so-called class-A properties, whose rents generally fall into a city’s top quartile, are increasingly coming under pressure.
The amount of U.S. class-A office space in central business districts that is leased fell in the fourth quarter of last year for the first time since 2021, according to Moody’s Analytics. The owners of a number of high-end properties recently defaulted on their mortgages, highlighting the financial strain from rising interest rates and vacancies.
“Any property owner that says ‘Oh we’re fine’ is a little bit fooling themselves,” said Thomas LaSalvia, director of economic research at Moody’s Analytics.
Some office landlords invested heavily in their buildings in recent years, adding spas, gyms, restaurants and modern elevators. The hope was that by modernizing their properties, these owners could benefit from a flight to quality as more tenants seek out environmentally friendly buildings with plenty of amenities and natural light.
This strategy has worked for some buildings, especially those developed in the past decade. Some new buildings like One Vanderbilt in Manhattan managed to add tenants at high rents.
But new leasing data and recent defaults indicate that many of these high-end properties aren’t immune to the office market’s crisis.
Take 777 South Figueroa St. in downtown Los Angeles. Completed in 1991, the 52-story tower features a lobby with 30-foot ceilings and rose-marble-covered walls, a landscaped plaza, valet parking and concierge services. Many of its tenants are financial companies and law firms, according to data from CoStar Group.
The owner, Brookfield Asset Management, recently defaulted on more than $750 million in debt backing the building and another Los Angeles tower. Meanwhile, asset manager Pimco recently defaulted on a mortgage backed by a portfolio of office buildings including the Twitter headquarters in San Francisco.
Older high-end properties are struggling in part because they face competition from towers built in recent years. In downtown Los Angeles, 28 office buildings have been completed since 2000, according to Moody’s Analytics.
In New York, new developments like One Vanderbilt and Hudson Yards have lured tenants from Park Avenue towers while pushing up Manhattan’s overall vacancy by adding new supply. Close to 19% of all high-end office space in Manhattan was available for lease in the fourth quarter of 2022, according to brokerage Savills, up from 11.5% in early 2019.
The availability rate for top-shelf office space was slightly higher than the availability rate at cheaper class-B and class-C buildings, Savills said.
Pressure on office occupancy is expected to continue for much of 2023. Weakening demand during the pandemic era initially came from companies cutting back on space by letting employees work from home part of the week. Now demand also is tumbling because big technology companies are hunkering down and cutting expenses for fear of a possible economic downturn.
Landlords who benefited from long-term leases are becoming more vulnerable as leases signed before the pandemic expire. Michael Silver, chairman of Vestian Global Workplace Services, said law firms he advises on their real estate often look to cut their space by around 30% when their leases expire. And unlike in 2021, more companies are worried about a recession and looking to cut costs.
“That’s just going to contribute to overall vacancy, and it doesn’t matter whether you’re in an A building or a B building,” he said.