As commercial real estate tumbles, some see opportunity in offices

The downturn in the commercial real estate market has investors looking for long-term buying opportunities — but the market's not for the faint of heart, nor of cash.

Office real estate in particular has taken a big hit as employers have given in to remote work or hybrid arrangements, dramatically lowering their need for square footage. That has caused occupancy rates to plummet, putting some property owners in a bind.

“This kind of scenario happened during the Great Recession. We have seen some Class A buildings — beautiful, brand-new buildings … being sold for pennies on the dollar,” said Boris Sanchez, CEO of commercial real estate firm Sanmore Investments. In the Houston area, where his company operates, one office building that fetched $140 per square foot in 2008 recently sold for less, he noted.

“There is a huge opportunity, especially in the office market, to pick up some of this,” Sanchez said. “I believe that the whole work-from-home thing will eventually taper off and become more hybrid.”

Over the past year, delinquencies by commercial mortgage-backed securities have risen gradually, going from 3.2% to 3.9% on average, recent data from Trepp show. But in the office real estate segment, the rate has nearly tripled, to 4.5%, compared with just under 1.7% a year prior.

Earlier this year, Pimco’s Columbia Property Trust, an office real estate investment trust, reportedly defaulted on more than $1.7 billion in debt associated with seven buildings, according to Seeking Alpha.

In offices across the country, the average vacancy rate was nearly 19% as of the end of the first quarter, data from Cushman & Wakefield show. The increase in vacancies of 550 basis points seen during the pandemic is slightly higher than the 465-bp rise that occurred during the 2008 financial crisis but less than the 915-bp jump following the dotcom bust, according to the commercial real estate services firm.

While many clients benefitted over the past few years from low interest rates and “substantial domestic migration affecting supply and demand,” in commercial real estate broadly, there could be opportunities arising amid higher rates to buy properties from overleveraged owners, Matthew Chancey, a tax specialist at Coastal Investment Advisors, said in an email.

“We are seeing opportunities to buy office [properties] at 25% of appraised values from just four years ago and below replacement cost,” Chancey said. “There is still uncertainty in the office market, but money is made when there is blood in the streets — and that feels pretty close to where we are in office today.”

One fund provider, Van Eck, recently filed with the Securities and Exchange Commission for the Office and Commercial REIT ETF, which would track the MarketVector U.S. Listed Office and Commercial REITs Index. That index includes REITs generating at least 50% of their revenue from office, retail or industrial properties. A representative for Van Eck said that the firm could not comment, given that the fund is in its registration period.

Across U.S. real estate mutual funds and ETFs broadly, $17.8 billion has bled from products since the end of 2018, including $6.9 billion this year through May, according to data from Morningstar Direct. Although investors funneled a net $17.5 billion into the funds in 2021, when total assets were $236.3 billion, they pulled $16.6 billion last year, helping drag assets down to $157.2 billion. As of May, the funds represented about $148 billion.

Returns for the broad category have been volatile, going from an average of -6% in 2018 to 27.3% in 2019, -4.5% in 2020, 38.7% in 2021, -25.7% in 2022 and 4.4% this year through May, according to the Morningstar Direct data.

Investors who are looking to snap up commercial office properties on the cheap should be considering the purchases as long-term holdings, Sanchez said.

“Those who can take advantage of the current office market will do that — but you can’t expect it to double next year,” he said. “Your rents are going to take a hit. There are a lot of ghost tenants that are waiting in the wings to leave.”

That means that buyers need to be creative when thinking about financing, rehabbing the properties and thinking of ways to bring more value to tenants, Sanchez said.

“The appreciation is going to be immense, but you can’t completely ignore cash flow,” he said. “Hopefully, [buyers] are not beginning investors, because this market will swallow you alive.”