Fitch: Office Property Performance to Worsen Amid Rising Market Pressures

Office loan performance will likely continue to weaken as market pressures build, reported Fitch Ratings, New York.

“We maintain a ‘deteriorating’ outlook on the U.S. office sector for 2023 given higher interest rates, a tighter lending environment and a secular decline in office demand,” Fitch said in its June 2023 U.S. Office Dashboard report.

Office loan delinquencies in Fitch-rated U.S. commercial mortgage-backed securities transactions could double to between 3.5% and 4.0% at year-end from 1.8% in May as more maturity defaults occur. “We expect continued negative net operating income growth for office properties in 2023, with lower quality urban office properties most affected,” the report said.

Property-level NOI for office loans in Fitch-rated conduit deals fell 1.8% on average in 2021 and 0.9% in 2022 due to rising expenses, early lease terminations and renewals at lower rents, reflecting rent concessions offered by landlords to secure new leases, Fitch noted. This contrasts with all commercial real estate property types, where NOI increased an average of 5.4% and 6.3% in 2021 and 2022, respectively, the report said.

The national office vacancy rate now equals 13.1%, up from 9.5% at year-end 2019, Fitch said. Additional sublease vacancies and lower tenant office needs contribute an additional 3.5%, resulting in a new record high total availability rate, 16.6%.

Fitch said it expects the national office availability rate to exceed 20% and market rents to decline 0.7% by year-end from 2022 levels and by a further 5% in 2024. It noted nearly 42% and 38% of conduit office loan volume maturing in 2023 and 2024, respectively, have more than 45% of the net rentable area vacant or scheduled to roll within the next three years.

Large metros with office vacancy rates above the national average include San Francisco (20.3%), Houston (19.2%), Dallas/Ft. Worth (19.0%), Chicago (16.1%), Washington D.C. (15.8%), Los Angeles (15.6%) and New York (15.1%), the report said. Average transaction sales prices also declined for most of these cities.