In the wake of the pandemic, a turbulent commercial real estate landscape is seeing a significant uptick in receiverships. That trend is especially noticeable across the Midwest, where several major cities continue to grapple with distressed assets, new opportunities and new post-pandemic realities.
Which markets are the most affected? What commercial real estate categories are bearing the brunt of the receivership volume and what are the prospects for owners, operators, real estate professionals and communities looking to calibrate a new normal in the wake of a historic disruption in the marketplace?
A region-wide phenomenon
Receiverships are up virtually across the board in the Midwest, with Illinois leading the way. Distressed or underperforming assets, as well as non-performing loans on the special servicer side, have become commonplace, resulting in unstable rent rolls from declining occupancy.
Things are not expected to be as bad as in 2008 and 2009, when the market paid the price for years of aggressive loan underwriting and questionable credit, but the expectation is that the next couple of years will continue to be busy. The focus is on the office market, undergoing a seismic shift as the result of new hybrid and remote work models, but retail has also been affected. While that does present an opportunity for real estate professionals who have expertise in this highly specialized space, it also presents a challenge for several Midwest markets that were undergoing significant expansion prior to the pandemic.
Relative to other Midwest markets, Chicago has seen a particularly high level of defaults and receivership activity, in part because of problems that predate COVID. High taxes, pension burdens and crime concerns were already presenting challenges before spring of 2020. Add pandemic pressures to that mix, and the result was the perfect storm to tip the Chicago office market into a tough spot.
While we saw many workouts on hotel and office assets, the hotel market has generally rebounded well. Office remains an open question, and we are likely witnessing a broader structural correction in that space. Chicago also had a surge of new construction, with the iconic Loop and downtown area not just a large office sub-market, but one that remains heavily reliant on mass transit, which has also been heavily impacted by the pandemic.
Smart property owners have been working to lessen the tax burden by appealing unfavorable tax assessments. However, simply appealing is an expense unto itself. Even successful appeals can be followed by subsequent increases, and so landlords must make worst-case-scenario assumptions regarding their tax burden.
Ohio has also seen a steep rise in receivership activity, with perhaps even more assets in REO than Illinois and more distressed assets than places like Wisconsin, Michigan and Minnesota. Unlike in Illinois, where it is relatively easy to identify factors contributing to that increase, Ohio is tougher to figure. One dynamic to watch is playing out in Cleveland, where a couple of large employers that have undergone significant post-pandemic downsizing has been enough to create turbulence in the market.
Michigan, on the other hand, is performing well relative to most other Midwest markets. This could be appointed to a comparative dearth of new office construction, or maybe because lenders have generally been a bit more conservative in Michigan compared to Chicago and other markets.
Office and retail
The receivership roles are filled with a wide variety of office tenants. Brands and businesses large and small are struggling to adapt to new realities with varying degrees of success. Landlords working to keep office tenants are facing decisions when asked to downsize space, which may require costly reconfiguration, at a moment when construction costs are at historic highs.
The high costs of tenant improvements put some office landlords in a difficult position, some of which are understandably leery about investing in costly repositioning for an uncertain return. In the retail sector, the outlook is more varied. Neighborhood centers are doing very well, but many big box retailers are struggling. Regional malls (many of which face larger structural challenges) are another significant source of retail receivership across the Midwest.
Solutions and opportunities
On the positive side, we are seeing some creative and compelling conversions from downtown office buildings to hotel and multifamily in cities like Cleveland and Chicago. Big box retail, and even some older hotels, are also being converted to multifamily.
Multifamily conversions are the most common category of adaptive reuse, but storage also continues to expand, both in big box spaces and multistory office space. Developers are looking for opportunities—and acquiring a vacant or underutilized office building at the right price could be a win-win scenario. Going forward, it’s incumbent upon receivers to work with owners and architects/developers to try and find those solutions.
Michael Kalil, chief operating officer, and William Bubniak, executive vice president, are receivership experts and brokers for Midwest full-service commercial real estate firm, Farbman Group. To reach Kalil and Bubniak directly, email firstname.lastname@example.org or email@example.com.