In the wake of the Covid-19 pandemic, the real estate landscape has shifted dramatically, with downtown office spaces suffering a significant blow while suburban offices have shown surprising resilience. This divergence marks a stark contrast to the aftermath of the 2008-09 financial crisis, when urban office spaces held up better than their suburban counterparts. Now, as remote work continues to reshape the property market, suburban offices are emerging as the more stable investment.
The Decline of Downtown
According to a recent analysis by The Wall Street Journal, downtown office valuations have plummeted by nearly 50% since their peak in early 2022, driven by the ongoing preference for remote work and the resulting reduction in demand for city-center office space. This decline has been exacerbated by the fact that downtown offices were once considered safe investments, with high demand and robust occupancy rates. However, the pandemic has altered these dynamics. City centers, which were once bustling with workers, have hollowed out as employees embraced the flexibility of working from home. The appeal of avoiding long commutes and the potential health risks associated with mass public transport have kept many workers away from their downtown offices.
The impact of this shift is evident in the struggles faced by large commercial real estate investors who heavily invested in downtown properties. Institutional investors like Blackstone and Brookfield Asset Management, who once favored these urban trophy assets, are now grappling with the financial challenges of maintaining them. As rents fail to cover debt repayments, these major players are increasingly willing to walk away from their properties, leading to foreclosures and further depressing downtown office valuations.
Suburban Offices: A Resilient Alternative
In contrast, suburban offices have weathered the storm more effectively. The valuation drop for suburban offices has been a more manageable 18%, reflecting the steadier demand in these areas. One key reason for this resilience is the commuting pattern of suburban workers, who are more likely to drive to work. This group returned to the office sooner, avoiding the mass transit concerns that have plagued downtown workers.
Moreover, the ownership structure of suburban office properties has played a significant role in their relative stability. These properties are often owned by smaller landlords or family offices with long-term investment horizons. Unlike large institutional investors, these owners are more inclined to work with lenders to find solutions for distressed loans, rather than walking away from their investments. This approach has helped suburban offices maintain a more stable financial footing.
The Future of Urban and Suburban Offices
As the article in The Wall Street Journal points out, the current disparity in performance between downtown and suburban offices may have lasting implications. High vacancy rates in city centers could become the new normal, with limited prospects for rent growth. Some cities are exploring the possibility of converting excess downtown office space into residential properties, but this solution is fraught with challenges. Many office buildings, particularly those constructed in the 1970s and 1980s, are not well-suited for conversion due to their large floor plates and lack of natural light.
Investors in public markets have yet to fully recognize the distinction between urban and suburban office assets. Real estate investment trusts (REITs) with a suburban focus are still trading at discounts similar to their downtown-focused counterparts. However, as the divergence in performance becomes more apparent, it is likely that the investment community will begin to reassess the relative risks and rewards of these two types of assets.
Conclusion
The post-pandemic world has upended the traditional hierarchy of office space, with suburban offices emerging as a safer bet compared to their downtown counterparts. While the challenges facing downtown offices are significant, suburban offices have demonstrated resilience, benefiting from different commuting patterns and more flexible ownership structures. As the property market continues to evolve, investors would do well to take note of these trends and adjust their strategies accordingly.
Reference: Ryan, Carol. “Downtown Offices Are Toxic. Suburban Ones Are Surviving.” The Wall Street Journal, July 4, 2024.