Only a Handful of Office Markets Exposed to Widespread Risk

Only a small number of office markets are at severe risk, even though debt service coverage ratios for offices have declined in recent years, according to CommercialEdge’s May 2024 national office report.

The DSCR measures net operating income against current debt obligations. It is used by lenders to decide if a business has sufficient NOI to pay back a loan. The ratio has been slipping for years as office cash flow fell and expenses rose, while interest rates and debt costs climbed.

Even so, the report found, “market-level average ratios show only a handful of markets exposed to widespread risk.” Most lenders require a DSCR of 1.25.

Five of the 91 markets analyzed had DSCRs below 1.0. They were Brooklyn (0.81), Oklahoma City (0.89), Chicago (0.9), El Paso (0.92), and Cleveland (0.96). Eight markets, including Manhattan (1.05), St. Louis (1.16), and Nashville (1.25), were on the borderline or below. And the downward pressure on DSCR is unlikely to lift in the near future, the report warned. Demand has all but disappeared, expenses are increasing, and any interest rate relief is unlikely to be sufficient to rescue properties at risk.

“However, it is important to note that these market-level rates are only estimates, and DSCRs can vary vastly from property to property,” the report commented. “Many properties within markets with low average DSCRs continue to perform well, while properties in markets with a high average DSCR face distress.”

The national average full-service equivalent listing rate was $37.66 per SF in April, a decrease of 8 cents from the previous month and 1.5% year-over-year, CommercialEdge reported. The national vacancy rate was 18.8%, an increase of 210 basis points year-over-year, and vacancies rose in almost every market.

Tech centers were worst affected. Year-over-year vacancy rose 650 bps in San Francisco and 400 bps in the Bay area and Seattle. Cities with a high number of financial jobs also suffered, especially Dallas – up 390 bps, and Charlotte – up 380 bps. Even the life sciences took a hit, with vacancies up 230 bps in Boston and 370 bps in San Diego.

In some cities, rentals did much better than their average. In New York, 550 Madison Ave. at $210/SF soared above the Manhattan average of $69.72, and in San Francisco, Sand Hill Commons at $204/SF was well above the market average of $59.30.

“Office starts have been nearly nonexistent in 2024, with just 3.2 million square feet of new space breaking ground through the end of April,” CommercialEdge reported. That compares to 44.2 million SF started in 2023, thanks to the growing life sciences and medical office sectors. The under-construction pipeline has plunged by more than 50% to just 83.7 million SF, with Boston the clear leader at 13,865,515 SF under way.

Even though some development may resume if interest rates fall, the report predicted it may be years until there is a meaningful uptick in office starts.

Prospects for a surge in workers returning to offices don’t seem bright. Citing the Bureau of Labor Statistics, the report said office-using employment has been stagnant during the year, with significant slumps in employment in the information sector and business and professional services.

Despite the generally gloomy outlook, the report said top-tier office assets in quality locations remain in demand. It cited the all-cash sale of 24th at Camelback 1, a 308,481-square-foot Class A building in a prime area of Phoenix, which traded hands for $86.1 million. The sale was to a family office based abroad. The same building sold for $100 million in 2018.

In total, transactions nationwide in 2024 totaled $7.5 billion, for an average of $157/SF.