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Office market categorized as ‘the big slowdown’

To paraphrase John Adams, numbers are stubborn things. Significant global events beyond economics helped guide the storied invisible hand. “At the beginning of the year we knew interest rates would rise, but we didn’t know the pandemic would continue to unleash waves of new variants around the world, exacerbating global supply chain disruption,” Rubin said. “And we couldn’t know that the first major war in Europe in 80 years would erupt, causing unimaginable human tragedy, dislocating the energy markets, and intensifying already high inflation. What a difference six months has made. The magnitude and unpredictability of change has resulted in a riskier investment market for all asset classes and the accompanying requirement for higher risk adjusted returns.”

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Taking his turn at paraphrasing, this time Hemingway, Rubin said the impact to the commercial office sector had been gradual and sudden: “The immediate impact of this more challenging investment environment, particularly the higher cost of capital, has been a slowdown in transactions,” he said. “Higher interest rates to real estate are like fire to a scarecrow. They reduce profit margins on new deals and can spoil the anticipated exit on existing deals. Accordingly, investors and their lenders are taking more time to model cash flows and valuations. The longer-term impact will bring both opportunity and pain. As the market transitions so will owners and investors, from the sprint of the last few years to a marathon.”

Side effects of the pandemic – behavioral rather than clinical – continue to affect the office market, posing significant risks for investors and owners: “The number of workers going back to the office is increasing every month,” Rubin observed. “However, most workers no longer want to be in the office full-time, especially as gas prices increase the cost of commuting. Office tenants are listening to their employees and watching their check books. Many are trying to renegotiate rent and reduce space prior to the expiration of their leases. Others will clearly reduce space and move to higher quality properties as leases turn. A recent tenant study by CBRE found that over 50% of respondents expect to reduce office space over the next three years.”

The advice now is to focus on the longer-term horizon, seen as an appropriate strategy in a period of volatility but healthy for the markets. “In the next few years, as market participants adjust to the new reality, it will likely take more capital and sweat to achieve success in real estate investing,” Rubin said.

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