Bottoming Out and Looking Up – August 19, 2024

VTS recently called a bottom to the office market in terms of new demand for space. That trough occurred in late 2022 and early 2023; since then, demand has experienced year-over-year growth on a monthly basis. Now Moody’s Analytics is seeing signs of pricing in the sales market reaching its cyclical low point. 

“Office Market Shows Signs of Nearing Bottom,” an analysis from Christopher Rosin, Kevin Fagan, Matt Reidy and Twinkle Roy, cited two signals that suggest that pricing may be reaching that floor. “Those signals are the stabilization of office trading volume currently occurring, and at the same time, owners of very large office properties capitulating and selling at large discounts compared to prior sales,” they wrote. 

It may seem counterintuitive to extrapolate signs of a market reaching bottom from a rise in sales volume. Yet it’s necessary to have more comparables to provide a frame of reference on pricing, and the Moody’s Analytics team has seen just that. 

“We have now recorded three consecutive quarters of year-over-year (Y-O-Y) increases in office sales,” they wrote. “While this is off of very depressed volumes and is still well below transaction volumes seen in 2021 and early 2022, the stabilization and small uptick in office transactions is encouraging.” 

The second signal they’re watching is “something we find much more interesting,” wrote the Moody’s Analytics team. “At typical market bottoms across the CRE investment spectrum, we tend to see a point where sellers capitulate. They throw in the towel, accept that prices are well below what they had hoped or face some internal economic reality like a maturing bullet loan, and they finally sell at a loss that is often quite sizeable. We believe we may be witnessing signs of market-bottom capitulation,” even if signs of this capitulation are often difficult to spot in the moment. 

Last year, the sale of 350 California St. in San Francisco made headlines at $61 million, less than a quarter of the asking price. However, the Moody’s Analytics team doesn’t see that as a true capitulation. That’s because the seller, which acquired the property as part of an entity-level deal in 2008, probably wasn’t on the hook for its estimated value. 

A handful of more recent sales do point to sellers gritting their teeth and accepting huge losses. Since the end of the first quarter of 2024, there have been seven repeat office sales at a loss of greater than $100 million each. 

In terms of dollar amount, the biggest loss was for the sale of 1740 Broadway in Midtown Manhattan. It was liquidated at $185 million, more than $400 million below the $600-million purchase price Blackstone forked over 10 years ago.  

On a percentage basis, the loss leader was 135 W. 50th St., also in Manhattan. Although the dollar amount of the loss was smaller, the property traded for about 3% of the selling price it fetched in late 2019, just before the pandemic cast a pall over the office sector. 

“While sales like this are typically very painful for equity holders and often bondholders, as was the case for 1740 Broadway, they are beneficial to the market,” the analysts wrote. “These sales provide the market with a tremendous amount of price discovery, which had been lacking. We understand that each of these transactions had unique circumstances, like 135 W. 50th St. being subject to sizable ongoing ground lease payments. Still, each transaction provides critical pieces of the valuation puzzle for other distressed office assets.” 

In short, the Moody’s Analytics team wrote, “We are seeing signs that the market is beginning to function in a healthier way.”