Office market trouble spreads to high-end luxury structures

High-end office buildings are seeing an increase in defaults and vacancies. This is the latest indication that remote work and rising interest rates are hurting more commercial real estate industry areas.

Buildings in prime locations with contemporary facilities fared better than their more affordable counterparts over most of the pandemic. Some even raised rents while values and vacancy rates soared in older, less expensive properties. Today, pressure is mounting on these so-called class-A properties, whose rents often fall into a city’s top quartile.

According to Moody’s Analytics, the amount of class-A office space in U.S. central business districts that was leased decreased in the fourth quarter of 2017 for the first time since 2021. Recent mortgage defaults by the owners of several upscale residences underscore the financial pressure caused by rising interest rates and vacant buildings.

According to Tom LaSalvia, director of economic analysis at Moody’s Analytics, “Every property owner who claims ‘Oh we’re good’ is a little bit kidding themselves.”

Upscale Office Buildings: Are Amenities Worth the Investment?

Recently, some office building owners invested significantly in their properties, constructing spas, gyms, restaurants, and cutting-edge elevators. These property owners hoped that by updating their buildings. They would profit from a flight to quality as more renters look for eco-friendly structures with amenities and natural light.

This method has proven effective for some structures, particularly those constructed in the last ten years. One Vanderbilt in Manhattan, a new skyscraper, was able to add tenants while charging hefty rents.

Yet, recent defaults and fresh lease statistics show that many of these upscale properties resist the turmoil in the office market.

Take South Figueroa Street at 777 in the heart of Los Angeles. The 52-story tower, finished in 1991, has a lobby with 30-foot ceilings and walls coated in rose marble, a landscaped plaza, valet parking, and concierge services. According to data from CoStar Group, many of its tenants are financial institutions and law businesses.

The building and another Los Angeles tower’s owner, Brookfield Asset Management, recently missed payments on debt totalling more than $750 million. Asset manager Pimco, whose office building portfolio includes the Twitter San Francisco headquarters, recently missed a mortgage payment.

The Struggle of Older Luxury Properties in the Face of Increasing Competition

Older luxury properties need help partly due to competition from towers constructed recently. According to Moody’s Analytics, 28 office buildings have been finished in downtown Los Angeles since 2000.

In New York, brand-new construction projects like One Vanderbilt and Hudson Yards have enticed tenants away from Park Avenue towers. Meanwhile, it raised the overall vacancy rate in Manhattan. According to Savills, the availability rate for premium office space was somewhat higher than that for less expensive class-B and class-C structures.

Throughout most of 2023, pressure on office occupancy should persist. Companies reducing space by allowing employees to work from home occasionally during the pandemic era led to a decline in demand. Demand is also declining due to major technological companies consolidating and reducing spending out of concern for a potential recession.

As leases signed before the pandemic expire, landlords who benefited from long-term leases are becoming more susceptible. Michael Silver, the Vestian Global Workplace Services chairman, noted that when law firms’ leases expire, they frequently aim to reduce their space by about 30%. In contrast to 2021, more businesses are concerned about a recession and seeking cost-cutting opportunities.

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