30% of U.S. office buildings, valued at $1.1T, are obsolete

[DCReid]

https://www.bisnow.com/chicago/news/...move-in-112258


It is only Tuesday, but it has already been a bad week for Chicago’s Loop office market. Commercial finance research firm Trepp reports the lenders of two significant office buildings have either taken possession of the asset or are on the verge of doing so.

According to Trepp, in November 2021 a $258M loan for Brookfield Asset Management-owned 175 West Jackson Blvd. fell delinquent and was sent to special servicing. This week, citing March servicing data, it reported the 1.4M SF office building’s lender had taken control. And after releasing a warning in December on a $100M loan for 135 South LaSalle St., Trepp now reports the special servicer for the 1.3M SF tower states the most likely outcome is a deed in lieu of foreclosure.

The properties’ troubles could signal a wider problem within Chicago’s Central Business District. Although downtown landlords have so far largely avoided a wave of foreclosures tied to the pandemic, the rise of hybrid work schedules over the past two years has office users rethinking their office strategy, with many now considering either shrinking their footprint or trading up into new spaces more enticing to workers currently at home. As tenants flood into new Class-A office towers in the West Loop, River North and especially Fulton Market, older buildings may find it tough to compete and keep their loans afloat, a pattern seen in other U.S. cities.

About 30% of U.S. office properties, with a total estimated value of $1.1T, face obsolescence as hybrid work entrenches itself into workplace culture.

Last year, 135 South LaSalle lost anchor tenant Bank of America, which occupied more than 800K SF, to a new trophy building at 110 North Wacker Drive. AmTrust Realty, the owner of 135 South LaSalle, plans to spend up to $100M to refurbish and upgrade a 4.7M SF portfolio of downtown Chicago buildings but decided to leave 135 South LaSalle out of the renewal effort, according to a December report in Crain’s Chicago Business.

Brookfield Asset Management bought 175 West Jackson in 2018 for $305M, according to Cook County property records. Once known as the Insurance Exchange Building, it was constructed in 1912 and designed by famed architect Daniel Burnham. It is home to the regional headquarters of the Securities and Exchange Commission and several financial firms, but ownership struggled to fill its floors and service the debt. In 2021, occupancy was 65%, Trepp reported.

Brookfield and LNR Partners, the special servicer for 175 West Jackson, didn't return calls seeking comment.

175 West Jackson isn't a relic. Clayco and the Lamar Johnson Collaborative completed a $100M modernization in 2002, led by architect Lucien Lagrange, that transformed the 22nd floor into a penthouse amenity suite, complete with a full rooftop deck. Tenants have also kept signing deals, including software tech firm WellRight, which last fall agreed to lease 17K SF on the 14th floor, and digital freight broker Loadsmart, which just moved its headquarters from New York to 34K SF in 175 West Jackson.

But it wasn’t sufficient. Due to decreased occupancy and net cash flow, the property’s troubled loan had already hit the watchlist last summer, according to commercial data research firm Reonomy, citing a report from the servicer. The loan was more than 90 days delinquent as of January 2022, with an outstanding balance of $138.7M.

Other Chicago office properties have undergone similar distress. The Civic Opera House Building at 20 North Wacker Drive was hit with a $195M foreclosure lawsuit late last year after the pandemic damaged many of its office tenants, according to a report in Crain’s Chicago Business. In addition, the former owner of 401 South State St, a historic, 487K SF office building, lost control of that property in 2020 after facing a foreclosure lawsuit.

Contact Brian Rogal at brian.rogal@bisnow.com


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https://www.bisnow.com/national/news...c-world-112245


Office occupancy continues to rise week-over-week, but at less than 40% of pre-pandemic levels in 10 of the country's largest markets, office owners aren't sleeping soundly just yet. And a new study might have them catching even fewer winks.

As much as 70% of U.S. office buildings face a loss in value in the near future, including roughly 30% of the nation's inventory, or about $1.1T worth at current valuations, facing complete obsolescence, according to a new study by real estate consultancy Zisler Capital Associates.

While that means 30% are safe, another 40% of the office building inventory is marginal, the study says. Many of those properties will need to be sold at prices low enough to justify the capital improvements necessary to bring them up to the energy efficiency and health standards of the near future.

Government energy efficiency standards are getting stricter, but so are tenant demands for healthier and more energy-efficient office environments, the study says. The coronavirus pandemic has helped accelerate the demand for better office space but is only part of the equation.

"While waiting for the pandemic to end, many investors don't recognize that obsolescence is devouring billions from office building values," Zisler Capital co-founder Randall Zisler, who authored the study, said in a statement.

If investors act now, they may be able to avoid this "tsunami" that is impacting office properties worldwide, Zisler added, noting that the UK has already barred leasing of offices that don't meet energy efficiency standards by 2023.

“We’re not saying bulldozers are arriving en masse,” Zisler said. “But you’re going to see a repricing and, in some cases, reuse of these buildings.”

Obsolescence already has created a green premium of 6% for leases in sustainable buildings, Zisler said. And tenants are now willing to pay a health premium, significantly pushing rental rates up over other office space.

Tenants are already leaving older office buildings in favor of newer projects, and the shift has left owners of some aging office buildings with large vacancies and insufficient cash flow to stay current on their debt.

"The problems going forward are going to come from primarily markets that have sizable amounts of dated properties that are not particularly desirable to big drivers of demand these days," Trepp Senior Managing Director Manus Clancy told Bisnow. "You’ll see episodes in New York, Chicago and other places where big buildings that back loans with nine-figure balances become distressed."

Contact Dees Stribling at dees.stribling@bisnow.com

[Steely Dan]

the towers being discussed here are giant old early 20th century behemoths:



135 S Lasalle | 1934 | 1.3M SF


source: https://www.skyscrapercenter.com/bui...onal-bank/3149



175 W Jackson | 1912 | 1.4M SF


source: https://www.chicagobusiness.com/arti...ffice-building

[pdxtex]

And just like that, we set American downtowns back 30 years.

[Steely Dan]

Originally Posted by pdxtex

And just like that, we set American downtowns back 30 years.

not necessarily, the market is shifting.

there's still lots of new office development going up and in the works in west loop/fulton market to be closer to the main metra stations.

and as a result of that westward push, some of these older giant central loop office properties are left a bit behind in the dust and can find themselves in white elephant status.

and this shift isn't a covid thing, it's been in place and building steam for the past 2 decades.

covid and WFH are obviously further complicating the picture now, but a central loop office address isn't what it was 40 years ago.

[kingkirbythe....]

Its a trillion dollar opportunity to remake downtowns.

Lemons to lemonade.

[TexasPlaya]

This is a pretty big issue in Houston where offices were built in waves during boom/bust periods. All those offices/office parks built in the 70s/80s (and there's a lot) have a very hard time competing with the wave of offices built in the 2000s/2010s.

Fortunately, some of the downtown classics are getting facelifts and upgrades, like this classic gothic one:

Iconic downtown Houston office tower renamed TC Energy Center

[llamaorama]

I think the extent to this is worrisome depends on what kind of buildings they are. If they are talking about office buildings like a 2-story insurance agency next to a highway exit in Iowa then who cares. I can only imagine if measured as distinct buildings these are a long tail.

However I do worry about larger structures in urban centers.

[TempleGuy1000]

I think we will just see more and more conversions to residential. Of course the ability to convert office to residential cleanly will depend on the floor layouts and what not, so it will be building specific.

[Yuri]

Houses and offices need refurbishment and maintenance. Architects always tell people that but they don’t pay attention.

[bnk]

Originally Posted by Steely Dan

the towers being discussed here are giant old early 20th century behemoths:



135 S Lasalle | 1934 | 1.3M SF


source: https://www.skyscrapercenter.com/bui...onal-bank/3149



175 W Jackson | 1912 | 1.4M SF


source: https://www.chicagobusiness.com/arti...ffice-building

Here I can see Condo, Rentals, and Boutique hotels in the Middle of the Loop. And still retain some small firms that like their location and do not need to be class A offices and like to pay less per sq foot. Think old small lawyer firms that have been in the area for a long time or some other start up that does not require
6 K internet in the next quarter.
The retail of the first levels in the central loop would have to follow to meet the needs of thousands of more residences but cities are always adapting and changing to meet the needs placed in front of it.


Both buildings look like they can have nice penthouses built at 1/8 of NYC or San Fran, just on costs of labor and mostly price of property.


Its been done many times over already.

And would be cheaper renovating the buildings in the same location than a tear down and redoing from scratch. Plus who would ever advocate for something like that, those are irreplaceable and cannot be made today for any cost. The units might be odd but people can be accommodating at a proper price point.


Those buildings cannot be torn town. Its the fabric of the city and its reuse will find value.


A decade ago the Old Post office was declared a building too huge to occupy.

Millions of sq feet. Most thought to make it work half of the building would have to be taken down. Now in retrospect it could have been even larger building with a similar sucess story.

Some of the loop business buildings that took the top spaces condo faced the lake by Grant Park so the views were great and I'm Sure the Monroe make money doing so.


There is no reason these old classic skyscrapers cannot adapt too. They will not be taken down and replaced with something else. Trust me.

Now its full and other buildings are being taken over in the same area expanding even further west into the Fulton Market boomtown.

BTW the original post was very Chicago loop centric, and I don't see other metros that would not be going through the same cycle. IMO this reuse could be a boon to not only the central city but the classic buildings themselves Irregardless if some think of them as obsolete in this day in age.

[jd3189]

I also agree with the sentiment that converting these buildings into residential or something else is the best bet. Affordable housing at just below market value or luxury for those who want to live in downtown. Landmark them both, if not done already.

[Emprise du Lion]

Originally Posted by llamaorama

However I do worry about larger structures in urban centers.

We're already there in St. Louis. The largest office tower in the entire metro area, and the entire state of Missouri as well, is still sitting vacant in downtown St. Louis.


Source: Loopnet.com

Built in 1986, 909 Chestnut boasts 1.4 million sq ft of space. Deal after deal has fallen through. Current estimates place the buildings value at only $9.2 million. A 95% decline in value since the building was last sold in 2006.

No exact reason has ever been disclosed why deal after deal has fallen through, but the fact that the building is dated and has virtually no attached parking has come up frequently as reasons why. AT&T walked out with the parking garage when they vacated the tower.

[pdxtex]

I hope these companies abandoning American downtowns start getting shamed. 1 year ago, were all in this together! One year later, yer downtown is failing? Yeah were outta here! So much for civics.

[C.]

Normally I would say convert them to residential, but the floorplates are far too wide. There will be a flood of defaults, a new owner will pick it up for pennies on the dollar, and they'll become the lowest costing lease rates in the city.

WFH is here to stay, and city planners waiting for the glory days of the 80s are going to be waiting a very long time. Residential/mixed-use is gotta be the way going forward or these downtowns will just be dead. Not even 9-5 anymore.

[pdxtex]

^^^^^Its like the introverts revolt. 10 years from now companies returning downtown will be regarded as heroes saving our beleaguered cities. Its going to be like Detroit all over again, when GM moved downtown out of guilt and the rest of SE Michigan followed.

[suburbanite]

We all love prewar skyscrapers, but the reality is that they are usually pretty terrible places to actually work. You can even be paying a premium for lower quality office space since the additional rent is so high due to the inefficient floorplates and building systems.

[Steely Dan]

Originally Posted by pdxtex

I hope these companies abandoning American downtowns start getting shamed. 1 year ago, were all in this together! One year later, yer downtown is failing? Yeah were outta here! So much for civics.

Which companies are abandoning downtowns?

The two chicago pre-war office buildings featured in the article that started this thread have lost tenants to brand new west loop/Fulton market office projects.

now, WFH/hybrid is making it much more challenging for them to refill the vacated space, thus hampering the ability of the owners to payback their hefty loans on them.

This isn't a case of companies abandoning downtowns for suburban office parks like it's the '80s all over again. It's WFH/hybrid making office space in older dinosaur buildings like these worth WAY less than it was when their current owners purchased them pre-pandemic. A painful value adjustment is unfortunately the most likely outcome here.

Originally Posted by C.

There will be a flood of defaults, a new owner will pick it up for pennies on the dollar, and they'll become the lowest costing lease rates in the city.

Exactly.

painful adjustment time.

[Steely Dan]

Originally Posted by Emprise du Lion

Source: Loopnet.com




the fact that the building is dated

What's weird though is that, despite being 36 years old now, it's still one of the youngest office towers in downtown st. Louis.

And when it became vacant 10 years ago, it was only 26 years old; it wasn't some decrepit century-old dinosaur that needed $100M+ to modernize ancient building systems.

Just about all of st. louis' significant urban office buildings constructed over the past three decades have been built out in Clayton.

I often wonder about how much healthier downtown st. Louis might be today if downtown Clayton had never become a thing.

my guess is that this building would've almost certainly not sat vacant for so long if there was no Clayton.

[Crawford]

Originally Posted by pdxtex

I hope these companies abandoning American downtowns start getting shamed. 1 year ago, were all in this together! One year later, yer downtown is failing? Yeah were outta here! So much for civics.

I think it's far more likely that those 80's-era sprawl office parks are finished. They were already obsolete pre-pandemic. Now you need a nice, central, amenity-filled office environment. Some highway-adjacent 1980-era lowrise structure doesn't cut it.

My wife's firm, which was mostly in shitty sprawl office buildings, is ending its leases in these buildings and consolidating in higher end, more central buildings.

[C.]

Originally Posted by pdxtex

I hope these companies abandoning American downtowns start getting shamed. 1 year ago, were all in this together! One year later, yer downtown is failing? Yeah were outta here! So much for civics.

This is melodramatic. It's not that companies are nefariously leaving downtown for the suburbs. It's that there is a shift in demand. Key points from both articles below:

*the rise of hybrid work schedules over the past two years has office users rethinking their needs, either by shrinking their footprint or trading up into new spaces more enticing to workers.

*Additionally, government energy efficiency standards (in the U.K.) are getting stricter, but so are tenant demands for healthier and more energy-efficient office environments, the pandemic helped accelerate the demand for better office space.

*Tenants are willing to pay a premium for healthier, more energy efficient spaces.

*Older buildings that don't get renovated or modernized lose out. Newer Class-A office towers downtown are seen as more attractive.

*Older buildings will need to be sold at prices low enough to justify the capital improvements necessary to bring them up to the energy efficiency and health standards of the near future.

On the last point, the wave of coming commercial defaults will be very bad news for real estate speculators, but it will eventually be a good thing for newer, smaller businesses looking for space. With the debt service wiped out, the older buildings can be leased at lower rates. It becomes an affordable option for the downtown market. Additionally, I'm reminded of Jane Jacob's observing the need for older buildings in the Death and Life of the Great American City. Older buildings tend to be less expensive to lease then their modern counterparts, leading to new energy and ideas that would not have been able to happen if everything was high rent.