Office Faces a Financing Gap of $73B

We all know the story by now. Things are about to get even more difficult for the nation’s office market, which already faces higher vacancies and declining property values. Owners that need to refinance could encounter a large funding gap in the near term due to lower loan-to-value ratios and substantial value erosion, according to an analysis by CBRE Econometric Advisors.

Specifically, the analysts calculate that office owners will face a financing gap of $72.7 billion between 2023 and 2025 – 26% of the lending volume originated in 2018-2020. To add to the misery, they conclude the funding gap is significantly worse for office properties than for any other sector.

Borrowers’ choices are limited. They may have to inject more cash into their properties or seek additional equity or mezzanine financing to pay off the existing loan. Or they can try to reach an agreement with the lender to agree to a discounted payoff or loan extension. However, the report points out, “Ultimately, some borrowers may be forced to default.”  Indeed, there have already been some high-profile defaults this year.

According to CBRE’s calculations, the total value of office loans originated in 2019 was $113 billion, with 78% due within five years at a loan-to-value ratio of 72%. By the second half of 2022, however, the loan-to-value ratio had fallen to 57% and the five-year value had slumped 29%. The resulting five-year funding gap by 2024 would total $38 billion. By 2025, the figure would reach $72.7 billion.

The situation is even worse than during the global financial crisis (GFC) of 2007 -2008. “The GFC was characterized by a steep one-year decline in office values followed by a quick recovery, whereas our forecasted losses are deeper and longer lasting due to secular decline in demand for office space and higher borrowing costs,” the report states.

The expected decline in office values is not uniform. The report predicts values in Manhattan, Houston, Philadelphia and Milwaukee could plunge by 40% or more by 2024. San Francisco, Chicago, Denver and Las Vegas would see falls of approximately 30%. Values would slip around 20% in Atlanta, Boston, Phoenix and Los Angeles and about 15% in Seattle, Austin and Portland. The dip would be around 10% in Washington, DC, Charlotte and Miami.

 The effect of this turmoil on market participants will vary. 

Some lenders may experience losses, and some could package non-performing loans and sell them on the secondary market at a discount. Other lenders are likely to pursue loan workouts and short-term accommodations. 

“At the same time, this gap will create many opportunities for equity investors interested in entering joint ventures at an attractive basis as well as creating significant opportunities for mezzanine lenders,” the report states.