Share of U.S. office buildings in distress surpasses hotel, retail properties

About $24.8 billion of U.S. office buildings were in distress at the end of the second quarter, surpassing previous leading commercial real estate laggards—hotels and retail properties.

The total value of offices that were financially troubled or already repossessed by lenders shot up about 36% from the first quarter, MSCI Real Assets reported Wednesday.

At the end of June, $22.7 billion of retail properties—including malls—and $13.5 billion of hotels were in distress. The total for all troubled commercial properties was almost $72 billion, up 13% from the first quarter.

“The office sector was responsible for the largest share of marketwide distress,” according to the report, based on filings for bankruptcies, defaults and other publicly reported property issues. “It’s the first time since 2018 that neither the retail nor hotel sector was the biggest contributor.”

It’s likely to get worse for offices.

“The things needed to slow the pace aren’t happening,” Jim Costello, an MSCI economist and a co-author of the report, said in an interview. “Investors are putting a low probability on debt becoming cheap and everybody being back in the office like they were before.”

MSCI identified an additional $162 billion of properties in potential distress, with problems such as delinquent loan payments, high vacancies or maturing debt.

U.S. offices face higher stress than other real estate sectors because of weak demand as remote work gains widespread acceptance. Office use in 10 major U.S. cities is at about half of its pre-pandemic rate on average, according to badge-swipe data from Kastle Systems. More than 20% of U.S. office space was vacant as of June 30, brokerage Jones Lang LaSalle Inc. reported.

Prices for office buildings fell 27% in the year through June, compared with a 12% decline for all commercial-property types, according to real estate analytics firm Green Street. Corporate landlords such as Blackstone, Brookfield Asset Management and Starwood Capital Group have stopped payments on office buildings they’ve deemed to be money losers.

Office properties with maturing debt are among the most vulnerable to stress because the cost of borrowing has soared since the Federal Reserve started raising interest rates last year to try to cool inflation. About $189 billion of debt on office buildings is estimated to mature in 2023 with an additional $117 billion due in 2024, according to the Mortgage Bankers Association.