Goldman Sachs: Office Property Mortgages Are A Ticking Time Bomb in the U.S. Banking Sector

A recent report from Goldman Sachs highlights rising delinquencies and maturing loans in US office mortgages, straining the banking sector. Declining demand for office spaces has led to a 19.7% vacancy rate, contributing to a 6.63% delinquency rate in commercial office mortgages as of February. Regional banks are particularly vulnerable due to their exposure.

Despite these challenges, retail, multifamily and industrial sectors remain relatively stable, offering diversification opportunities. Moreover, banks are in a stronger capital position compared to past crises, suggesting resilience. Strategic management and innovative solutions are key in navigating the potential crisis and fostering resilience.

Commentary from Dominic Vinti, SMARTCAP's Senior Acquisitions Analyst 

A recent report published by Goldman Sachs stated mortgages tied to office properties in the US were “living on borrowed time.” Delinquencies have risen to 6.63% on office mortgages, which is a 4.25% increase year over year. The total amount of commercial mortgages due through 2024 has swelled to $900 billion, or a 41% increase. This increase has been caused by the “blend (or pretend) and extend period,” meaning lenders have extended or modified current loans to try and wait out the poor demand in the market. The optimistic news for this potential bubble is the capital condition of the banks – compared to the GFC of 2007 and 2008 – along with the stability of other main asset classes in broad supply and demand fundamentals. 

The looming debt maturities in office properties should be especially worrisome for Seattle. Banks have modified and extended for long periods of time to try and wait out and limit material losses to their balance sheets. The two keys to navigating this difficult market in commercial office lending are interest rate cuts and a rebound in tenant demand. Unfortunately, neither have gone the right direction in 2024. Inflation has remained persistent, and rate cut expectations have been scaled back significantly from predictions at the beginning of 2024. Seattle’s office rebound is also lagging other peer markets. The city’s workforce still largely prefers remote or hybrid work compared with that of other major metros, further muting office bounce back. Seattle’s downtown is becoming cleaner and safer, but it still has a way to go before returning to pre-pandemic norms. Hopefully banks and ownership groups can weather the storm longer to wait out this period of high interest rates and stagnant tenant demand. 

Invesco Real Estate Buys 203,500 SQFT Warehouse in Auburn for $45MM

In Auburn, an industrial property within the Emerald Corporate Park was recently acquired for $45 million by an entity affiliated with Invesco Real Estate. The one-story warehouse, covering approximately 203,497 square feet on 7.52 acres, was sold by an entity associated with Mesa West

Capital, a commercial real estate lender. Invesco, a global investment management firm with a vast portfolio exceeding $1.5 trillion in assets worldwide, continues to expand its holdings in the region. This transaction marks another significant addition to Auburn's active industrial property market, following Invesco's prior acquisition in Fife last year.

Commentary from Spencer Esau, SMARTCAP's Acquisitions Manager

Emerald Corporate Park recently sold for $45 million, implying a 4.9% capitalization rate at $221 per square foot. This transaction is significant for the region's investment landscape, particularly considering the subdued investment sales activity in the Seattle area over the last two years. Amidst the challenge of price discovery, the aggressive capitalization rate for a fully leased asset serves as a positive signal for property values. We anticipate a gradual uptick in transaction volume over the coming 12 months as market participants adapt to the substantial macroeconomic shifts in the commercial real estate sector over the last few years.

Tech Titans Tighten Grip on Eastside Office Market

In Q1 2024, the Eastside's office market activity surged, with 1.1 million square feet pre-leased upon delivery. Vacancy rates slightly decreased to 22.7%, but the I-90 corridor's vacancy soared to 42.1%. Bellevue Central Business District (CBD) leasing remained stable but offered concessions. Over 2 million square feet of new construction could push vacancy rates above 24% by 2024's end. Recovery depends on potential declining interest rates but uncertainty persists.

Commentary from Brian Burmester, SMARTCAP's Director of Acquisitions 

While demand from larger corporations remains subdued, there's a noticeable surge in interest from mid-sized businesses eyeing top-tier office spaces spanning from 25,000 to 100,000 square feet. This trend is particularly pronounced in the Bellevue CBD, where companies are gravitating toward prime locations that require minimal capital investment.

Despite the Bellevue CBD's vacancy rates hovering just above 10%, the availability rate, which encompasses both vacant spaces and those available for sublease, stands at approximately 25%. In contrast, SMARTCAP’s office portfolio is outperforming the Eastside’s core market.

SMARTCAP has traditionally focused on targeting multi-tenant suburban office assets, catering to tenants ranging from 1,500 to 25,000 square feet. For instance, our current office portfolio totals 420,000 square feet across six assets, boasting an impressive occupancy rate of approximately 88% as of Q1 2024.  This segment of the market tends to maintain higher occupancy levels, as it has less exposure to large tech tenants who consistently expand and contract their space requirements.