Office Is Facing a Sizeable Rollover Risk in the Next Two Years

CRED iQ reviewed CMBS loans with office collateral through 2025 and found that about 217 million square feet are office leases with expiration dates this year and next.

That is quite a sizeable near term rollover risk.

Lease expiration figures were further parsed by geographic location to provide a granular view by MSA. A detailed view of lease expirations by individual office market helps identify which markets’ vacancy rates are at risk of being stressed.

The top five metros with total square footage expiring through 2028 are New York-Northern New Jersey-Long Island, NY, NJ, PA (173.4 million s.f.); Los Angeles-Long-Beach-Santa Ana, CA (51.9 million s.f.); Chicago-Naperville-Joliet, IL-IN-WI (45.5 million s.f.); Philadelphia-Camden-Wilmington, PA-NJ-DE-MD (32.7 million s.f.); Washington-Arlington-Alexandria, DC-VA-MD-WV (31.3 million s.f.). To show the scale, the smallest of the top 25 areas are New Orleans-Metairie-Kenner, LA (8.4 million s.f.); Charlotte-Gastonia-Concord, NC-SC (8.3 million s.f.); Kansas City, MO-KS (8.2 million s.f.); Indianapolis-Carmel, IN (7.6 million s.f.); and Las Vegas-Paradise, NV (7.5 million s.f.).

However, there is heavy top-heavy concentration with a lot of potential pain distributed throughout the country. For a sense of how badly things can go, according to CRED iQ, the Worldwide Plaza Tower in New York secures a $940 million loan. A third of its net rentable area faces vacancy in 2024, especially as its second largest tenant, law firm Cravath, Swaine & Moore with 30% of the overall space, sees a lease expiration at the end of August. The firm has already said that it will let the space go and consolidate at Hudson Yards. Occupancy in September 2023 was 91%.

As CRED iQ notes, the pressure of hybrid work and work-from-home has pushed many occupiers to reconsider how much space they actually need. Then, with the reconsideration of space needs of those tenants and their desire to attract workers back into the office comes the consideration of a move to quality. Upscaling the office, although there’s a serious question of whether there is enough to satisfy everyone. The most attractive and desirable office space is only between 10% and 15% of total inventory, says Cushman and Wakefield. Demand for the buildings is high. Top-tier space in gateway markets enjoys vacancy rates that are 700 basis points lower than the remaining market. Direct vacancy in the best buildings is sub-11% — an impressive number in relative comparison.

“To be fair, many tenants will renew or even expand footprints in certain office buildings. However, rising vacancy rates — in excess of 20% and even reaching 30% in certain markets — indicate a high level of risk that many tenants will downsize or fail to renew altogether,” CRED iQ wrote. “Lease expirations may have possibly favorable outcomes for office landlords, including a renewal or new direct lease that resets rents higher if market conditions allow. However, high vacancies and downward pressures on net effective rents may lead to reductions in cash flow and trigger subsequent distressed scenarios.”

That means a lot of landlords had better be working on risk management and contingency plans going forward.