It remains a tale of two markets in the U.S. office sector. And one of those markets? The online auction format could prove a true benefit to it.
That’s the thought of Steve Jacobs, president of online CRE auction company Ten-X Commercial.
As Jacobs says, investors are still interested in high-quality Class-A office space. So are tenants, which is why the vacancy rates tend to be lower for newer office space that offers plenty of amenities.
But older Class-B and -C office properties? Those spaces aren’t attracting investment dollars. They’re seeing soaring vacancy rates. And the situation for these outmoded office properties isn’t improving.
One solution? Jacobs says that the owners of those older office properties should consider the online property auction, which has proven to be a successful way for owners to sell Class-B and -C office properties that need reinvention.
Jacobs says that Ten-X has seen steady year-over-year growth in the number of Class-C and -B office properties on its platform since the start of the COVID-19 pandemic. As Jacobs says, the online auction format provides these owners a type of “escape hatch” to unload underperforming office properties.
This is a trend that Jacobs says will only gain strength as more office space is removed from the market and sellers need a fast method of offloading their lower-quality buildings. According to Ten-X’s statistics, the company boasts a trade rate of 58% with its online auction format, more than twice the rate of sale compared to traditional listings. Online sales close quickly, too, with Ten-X reporting that properties on its platform move from list to close in an average of under 100 days, again twice as fast as offline transactions.
“The auction format expedites a transaction’s timeline,” Jacobs said. “The typical timeline to transact commercial real estate is five to seven months. With our process, we are selling and closing in 98 days on average. That was our average timeframe last year. That’s whether you are selling a Class-A, -B or -C property. If a seller wants to sell and monetize the transaction quickly, the auction format is a great option. That is the overarching theme, regardless of asset.”
Desperate times for office owners
There has been plenty of chatter that office building owners can convert their high-vacancy properties into other uses, with most suggesting that they can transform these spaces into multifamily units.
That’s often expensive, though. And it requires the right type of office building in the right location. Many Class-B and -C office properties can’t be converted to other uses. As Jacobs says, these properties are often located in less-desirable neighborhoods. They might have lower ceilings, smaller floorplates and structural issues.
“To convert those into something new and shiny is more difficult,” Jacobs said.
Class-C and -B office buildings are struggling, too, because of the flight to quality that is happening in today’s office sector. Many tenants, because of the enduring strength of the work-from-home movement and hybrid schedules, are reducing the amount of office space that they need. When they move to a new office building, then, they are often relocating to higher-quality Class-A space. They can afford this move because they are renting a smaller amount of square footage.
This leaves the owners of lower-class office space with even more vacancies.
“This isn’t all about the pandemic. It’s about the flight to quality, too,” Jacobs said. “If you are the owner of a Class-C building and you can’t reposition it — you can’t knock it down and build housing — you want to monetize that property as quickly as you can. The auction format is good for that.”
Jacobs said that more owners of these older buildings are doing just that. Ten-X has its first auction of the year later this month. Jacobs said that most properties in the auction are Class-C buildings. The occupancy rate in these buildings ranges from 0% to 49%.
What kind of buyer will the auction attract? Jacobs says that he sees a variety of investors for his company’s online auctions, mostly depending on where the assets are located. A C-building in a stable market like Irvine, California, will attract more potential buyers than will properties in less-desirable markets.
Properties not in “A” markets tend to attract local investors, Jacobs says. A group of high-net-worth local investors might pool their dollars, buy an underperforming office building and turn it into, say, a medical office.
Other local investors might turn a Class-B or -C office property into a professional building with doctors, dentists or lawyers who need smaller suites.
“There is a lot of money out there,” Jacobs said. “There is a ton of money waiting to buy, for example, a Baltimore high-rise office property for a low price. Those investors know that they can turn that building into the best office property in Baltimore if they are buying the property for 30 cents on the dollar. They know that they can charge lower rent and lease-up their building if they spend less on it upfront.”
And the sellers participating in online auctions today? Jacobs says that some institutional owners are willing to sell their office space at a discount, taking the loss on a property and moving on. They can then purchase a new office asset – or other asset type – at a lower price.
Other sellers, even if they are not distressed are stressed, Jacobs said. They might have purchased an office building four years ago for $8 million with $7 million in debt at 3.5% interest. The market has since shifted, and the buildings that they purchased might now be worth $6 million. They haven’t defaulted on their loans, but they might have to negotiate with their lenders if they want to sell their properties for what they are worth today.
As Jacobs says, buyers won’t get great deals when working with these stressed sellers. But these types of deals will offer opportunities for buyers willing to spend market-rate for an office property. He predicts that more of these sales from “stressed but not distressed” owners will happen in 2024.
Like others in the commercial real estate business, Jacobs says that he expects CRE sales activity – both offline and online – to increase in 2024 now that the Federal Reserve Board has indicated that it will no longer be increasing its benchmark interest rate.
But this increase in sales might not happen until the second half of the year as investors wait for interest rates to not just stabilize but fall.
“I do believe investors love the idea that rates aren’t going to go up,” Jacobs said. “But I do think that investors also have the sense that rates will go down this year. Many have told me that they are going to wait to see in the next six months whether rates do fall. They will wait until they see that first decline in rates before they buy something. Right now, all we have is a prediction that rates are going to go down. We don’t have the rates falling yet.”
No lost causes
And in good news for the owners of underperforming office space? Jacobs says that he doesn’t view any office property as a lost cause. As he says, everything sells for the right price. That price might not be what owners want, but there is a price for every office property, Jacobs said.
Jacobs says that there are many office properties that will be auctioned this year by Ten-X that have been built in the 1980s and are stuck with sky-high vacancy rates. Even these properties will sell by auction at the right price, he said.
“If you price it right, someone will buy it and figure it out for you,” Jacobs said.
For those office buildings that are the direst of straits? Jacobs often recommends an absolute-bid auction. In these auctions, the owners agree to accept the highest offers they receive, even if they come in low.
“You take whatever you can get for it,” Jacobs said. “The owners get rid of the taxes and obligations and get out of the deal. Many times, those properties sell for several hundreds of thousands of dollars because you’ll get several bidders. You might still get a low price, but you end up with more than you expected because some other bidder views the space as a useful piece of property.”