Not All Office Properties Are Problematic

For a while, some voices in CRE have been raising a counterpoint to the dirge that office as a class is doomed. A doom loop/? Not quite. That maybe the issue is a lack of the right types of properties.

A recent analysis by Jim Costello, executive director of research at MSCI, falls into a similar vein. The basic point: not all office buildings are the same and while worst-case scenarios are possible, they are unlikely to be everywhere.

At the heart of this view is the variability of price contraction. Overall, the office market has taken a significant hit. The RCA Commercial Property Price Index (RCA CPPI) for the segment in the fourth quarter of 2023 was down 16% from the same period in 2022. Sales of offices in that quarter were 66% below the five-year fourth quarter average before the pandemic. In other words, prices haven’t fallen enough for the market to clear.

“Unless some outside force drives sudden new excitement around office investment, current owners of assets will likely need to endure further price declines if they need immediate liquidity for their holdings of office buildings,” Costello wrote.

Occupancy is down since 2020 to the point that there are reports of “record-high vacancy in office buildings.” That drives down the prospective revenue, which means there is less value to buyers.

Costello then uses the MSCI Price Expectations Gap to estimate how much further prices would likely have to fall to bring buyers and sellers back into balance and to restore activity. In the first quarter of 2022, the RCA CPPI was at this historical high. The average price level of offices sold at the time was about $408 per square foot. Given the price fall of 40% since then, you could estimate the price in the last quarter of 2023 was $245 per square foot.

Only, according to the MSCI Price Expectations Gap, there was a -19.7% difference between asset price expectations between buyers and sellers in central business districts. Split the difference and it suggests that the clearing price should be $221 per square foot and price range between $221 and $245 in the first quarter of 2024, or a loss of between 40% and 46% compared to the top price.

By contrast, in suburban office, the MSCI Price Expectations Gap was -9.5% at the end of 2023. “Given the cumulative 17% decline in the RCA CPPI for suburban assets seen between the peak in Q3 2022 and the end of 2023, that gap implies investors would realize a loss of between 17% and 21%,” he wrote.

In other words, while there is bad news for office owners, whether in a CBD or suburb, the worst news isn’t evenly distributed across the country.

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