Loan Defaults Are a Dangerous Emerging Trend, a Veteran Broker Warns    

David Baird has more than four decades of CRE experience. Image courtesy of Sperry CGA

The office sector is undergoing a phase of transformations, mainly due to the continued popularity of remote and flexible work models, and tenants’ need to reevaluate their office space usage. Additionally, the current economic environment and high interest rates are adding fuel to the fire, pushing some lenders to the sidelines and forcing office owners to reconsider and adapt their strategies.

“The new loan market for offices has dried up,” said David Baird, national director of institutional investments at Sperry CGA, a brokerage services company based in California. “Even with new capital being infused, the lenders typically will ‘extend and pretend’ or ‘delay and pray’ that the market will improve.”

Commercial Property Executive asked Baird, who has more than 40 years of experience, to discuss the current dynamics in the office lending space, and expand on his firm’s response to maturing debt.

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What are the top trends you’re noticing in the office sector today and how is Sperry Commercial responding?

Baird: The top trend we are seeing in commercial real estate today is the emergence of loan defaults based on maturity and high-interest rates. Loan defaults are continuing to rise and are a dangerous emerging trend. Leading the race to the default table is the office market. As loans come due, office properties are unable to produce enough income due to vacancies to support a new loan.

Lenders are refusing to work with owners to refinance their loans without significant additional capital being infused by the borrower. In response to this evolving market, which affects all commercial properties to varying degrees, Sperry Commercial has put together the Commercial Property Resolution or ‘CPR’ team.

The team has the experience and depth to handle loan restructuring, management, auction, and legal issues associated with the restructuring. Our team of seasoned professionals has been extremely successful at restructuring the loans for the borrowers. The Sperry CPR team gives borrowers options rather than simply handing back the keys.

Where does most stress come from for office landlords? 

Baird: Office overall is the most affected by the current market conditions. The stress comes from a change in the work environment for office workers. The work-from-home trend has caused office vacancies to accelerate. This may be a permanent change causing the office property owners to adjust to the phenomenon.

Even though some office markets have performed better than others, all office properties regardless of their financial performance still must deal with loan maturity issues. Lenders are reluctant to loan on office properties without additional capital being added. Markets like San Francisco are the most affected due to the work-at-home problem in the tech sector. This scenario appears to be a long-term issue until the market adjusts.

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Please tell us about a notable office transaction that you have been involved in recently. What made that deal stand out?

Baird: A notable sale was a sale-leaseback. The leaseback was only for one year on a 200,000-square-foot building. This stands out because the San Francisco market has such huge vacancies…The sale was handled by Eastdil Secured. Office transactions are at an all-time low due to financial fundamentals. With cash flow diminishing and expenses rising, the brokerage community is seeing a void of transactions.

How have tenants’ and landlords’ changing needs impacted office values? 

Baird: Currently, we are in a major demographic shift in office. The work-from-home evolution has caused large office vacancies. Tenants don’t require the space they had previously required. As vacancies rise and loans come due, office assets can no longer service the debt. Values drop and lenders are reluctant to loan against office properties. The CPR team works with the lender to get a resolution and give the owners options they may not have thought of.

Which commercial real estate asset types have been least affected by the current economic conditions? 

Baird: In our experience, the least affected property types by current conditions seem to be industrial and multifamily. However, many contributors say much more distress is on the way, affecting most property types.

What should office landlords do while tenants figure out their occupancies?  

Baird: The market needs to adjust to the new reality of excessive office space. This may take years to accomplish. Until this adjustment completes this phase, landlords need to be creative and reset their expectations. Flexible working hours and in-office requirements will bring back employees to the office workspace. Landlords will adapt by reducing space and renegotiating their loans to adjust to the new reality of fewer people occupying the space.