Office market woes extend to high-end luxury structures

High-end office buildings are seeing a rise in defaults and vacancies as the latest indication that remote work and rising interest rates are hurting more areas of the commercial real estate industry.

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

According to Moody’s Analytics, the amount of Class A office space in the US central business districts that was rented decreased in the fourth quarter of 2017 for the first time since 2021. Recent mortgage defaults by the owners of several luxury residences underscore the financial pressure caused by rising interest rates and empty buildings.

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

Recently, some office building owners have invested significantly in their properties, building state-of-the-art spas, gyms, restaurants, and elevators. These owners hoped that by upgrading their buildings, they would benefit from a flight to quality as more tenants seek green structures with many amenities and natural light.

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

However, recent defaults and new lease statistics show that many of these luxury properties are weathering the turmoil in the office market.

Take South Figueroa Street to 777 in the heart of Los Angeles. The 52-story tower, which was completed in 1991, has a lobby with 30-foot ceilings and walls lined with pink marble, a garden plaza, valet parking, and concierge services. According to data from CoStar Group, many of its tenants are financial institutions and law firms.

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

The struggle of the oldest luxury properties in the face of increasing competition

Older luxury properties need help in part because of competition from recently built towers. According to Moody’s Analytics, 28 office buildings have been completed in downtown Los Angeles since 2000.

In New York, new construction projects like One Vanderbilt and Hudson Yards have lured tenants out of Park Avenue towers while driving up the overall vacancy rate in Manhattan. According to Savills, the vacancy rate for the premium office space was somewhat higher than for the less expensive Class B and Class C structures.

Through most of 2023, office occupancy pressure is expected to persist. Companies that cut back on space by allowing employees to work from home occasionally during the pandemic era led to decreased demand. Currently, demand is also declining as a result of major tech companies consolidating and cutting their spending amid fears of a possible recession.

As leases signed before the pandemic expire, landlords who benefited from long-term leases become more susceptible. Michael Silver, president of Vestian Global Workplace Services, noted that when law firms’ leases expire, they often aim to reduce their space by about 30%. Unlike 2021, more companies are worried about a recession and looking for cost-cutting opportunities.

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