THE OUTLOOK FOR OWNERS OF OFFICE BUILDINGS

The Outlook for Owners of Office Buildings
Hello bank… bye, bye property!

If I am right about the future, the value of office buildings will plummet, causing mortgage balances to be higher than the value of the buildings.

⦁ Large amounts of prior unpaid rent and other charges will never be fully collectable.
⦁ Many tenants were forced to close their businesses permanently leaving owners with many vacancies.
⦁ With little or no tenant revenue received owners needed to make loans or invest additional capital to pay the properties expenses and debt service.
⦁ Owners received 3 – 6 months of interest and/or principal deferrals from the lender which will need to be repaid.
⦁ Tenants were indeed suffering but many chose to use the pandemic as an opportunity to renegotiate their leases and lower their rent and other obligations significantly. 

Office building owners are facing insurmountable difficulties that will soon cause them to tap out and abandon ship. Such challenges include that:

Post Pandemic Issues Facing Owners (the Bleeding Continues)
⦁ Tenants are demanding the earth, moon and stars in exchange for their tenancy.
⦁ Their buildings immediate area is inundated with vacancies causing less demand and rental rates to plummet.
⦁ Lease terms will soon be expiring leading to renewals at drastically lower rents and tenant obligations.
⦁ Leery of another Covid related incident tenants are demanding pandemic cancellation clauses in their leases.
⦁ Tenants are less willing to provide personal guarantees as they did under their prior leases which reduces the creditworthiness of the property.
⦁ Owners are having a great deal of trouble refinancing their mortgages.


The Exorbitant Cost of Re-renting Vacant Space
Adding insult to injury, owners will not only need to continue funding shortfalls but will incur the following significant additional costs to obtain new tenants.

⦁ Vacancy losses – 3-6 months
⦁ Substantial brokerage fees
⦁ The need to offer free rent periods of 3 – 8 months to the new tenant
⦁ Incur large renovation costs as well as needing to provide large tenant improvements allowances to the new tenant.
⦁ Rent the space at a significantly lower rent.

Besides the significant loss of cash flow and the large capital costs to rent the vacant space, the killer shark in the water is the reduced rent the owner will receive resulting in a direct plummeting of the value of their buildings.


Example:
Assume the market rent prior to the pandemic was $65 per SF and currently it’s dropped to $60 per SF which is being conservative. Further assume that the vacant space consisted of 10,000 SF. The reduction in rent of $50,000 per year results in a dollar for dollar reduction in Net Operating Income. Assuming a cap rate of 5% the value of the property plummets by an astounding $1,000,000. This doesn’t include the loss of $50,000 per year or more over the tenants new lease term and the huge outlay of capital to obtain the new tenant. And this example only applies to one rather small tenant. Stores located on the ground floor paying $100 – $200 per SF will start crying that they can’t afford the rent because there is not enough traffic generated from the building and these rents will also significantly decrease. It’s a complete shit show for the owner.

 

Example:
Assume the market rent prior to the pandemic was $65 per SF and currently it’s dropped to $60 per SF which is being conservative. Further assume that the vacant space consisted of 10,000 SF. The reduction in rent of $50,000 per year results in a dollar for dollar reduction in Net Operating Income. Assuming a cap rate of 5% the value of the property plummets by an astounding $1,000,000. This doesn’t include the loss of $50,000 per year or more over the tenants new lease term and the huge outlay of capital to obtain the new tenant. And this example only applies to one rather small tenant. Stores located on the ground floor paying $100 – $200 per SF will start crying that they can’t afford the rent because there is not enough traffic generated from the building and these rents will also significantly decrease. It’s a complete shit show for the owner. Perhaps more tenants will be able to succeed because of the lower rents. Hopefully in the near future the pandemic will be just a bad memory. Should this become a reality it should provide a more stable environment that lenders will embrace leading to more competitive financing opportunities and lower caps rates. This situation would provide an opportunity to refinance mortgages at lower interest rates, better terms and possibly reduce the purchaser’s capital investment. In my opinion there soon will be many properties available for purchase at bargain basement prices. This opportunity will provide new investors with high cash-on-cash returns on investment and the potential for significant appreciation in the future. 


What’s the Word on the Street? 

My advice is to tap into your contacts and start picking their brains. Talk to bankers, office leasing and mortgage brokers, bankruptcy attorneys, etc. Get on the foreclosure lists of banks and other financial institutions so you always have access to the latest offerings. I have a feeling there will be some big players snatching up a massive amount of real estate for pennies on the dollar. Why can’t you be that big player? Get ready to go on a shopping spree. Play to your strengths, use your street smarts, and be a savvy investor. Take advantage of the oncoming opportunities in the real estate market to further your own holdings. 

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