<img height="1" width="1" style="display:none" src="https://www.facebook.com/tr?id=669891663901487&amp;ev=PageView&amp;noscript=1">
Skip to content

    How the Rise in Office Loan Defaults Will Impact CRE Development


    Defaults on loan payments for unused office buildings are on the rise, as owners of Class B and Class C properties face dual headwinds from the ongoing prevalence of remote work and the high-interest rate environment. The commercial real estate firm Cushman & Wakefield estimates about 20% of office space is vacant at present, with the number even higher in cities like San Francisco where the tech industry’s embrace of remote work puts vacancies closer to 30%. As a result over $38 billion of U.S. office buildings face loan defaults, foreclosures, or other forms of distress, a situation which could have implications across the commercial real estate development industry. 

    Office loan defaults are likely to introduce new challenges into the real estate sector, putting further stress on banks and reducing access to capital. This could be bad news for developers looking to get new projects off the ground, as the high-interest rate environment and ongoing economic uncertainty have already stalled capital deployment over the past couple of years. However, cautious lenders don’t have to derail your firm’s plans, and new obstacles posed by office loan defaults can be overcome with the right planning, strategies, and tools. You may even find new opportunities come out of office vacancies, such as a rise in government programs meant to boost adaptive reuse projects. 

    Here you’ll learn more about the rise of office loan defaults and its impact on the broader development industry, as well as the challenges and opportunities your team should be aware of: 

    Understanding the Looming Office Loan Default Crisis 

    Office loan defaults have been a concern since 2020 when the shift to remote or hybrid work amid the COVID-19 pandemic dramatically reduced demand for office assets. Many companies have opted to reduce office space as employees continue to work remotely, resulting in high vacancy rates. Class A office space, which prioritizes amenities and positions the office as a destination for workers, has proven to be more resilient, but Class B and Class C buildings are still struggling to draw tenants back. 

    Loan defaults have also jumped up in 2024 because the long lease terms on office space rented before the pandemic have lapsed and companies moving to a remote format are not renewing tenancy. Additional economic turbulence caused by the pandemic, such as the high interest rate environment the Fed instituted to fight inflation and subsequent purse tightening from banks, are also leaving developers with fewer options when it comes to distressed office assets. 

    In February, about 6.3% of all commercial official mortgages were delinquent, up 33 basis points from January. The statistics also reflect a year-over-year increase - a year ago only 2.38% of loans were delinquent, according to a Trepps report. U.S. office market demand has declined for the last eight quarters, with office vacancies reaching a high of 19.7% at the start of the year, with both leading to the rise of loan stress in the market.

    Goldman Sachs analysts predict that many properties may not rebound from the fallout of the pandemic, and subsequent extensions and modifications of existing debt push the amount of commercial real estate loans expected to mature to $929 billion by the end of 2024, an increase of 41% from a year prior. Goldman notes banks have raised allowances for commercial real estate loan losses, but downward pressure on office property prices and net operating income growth could lead to more strategic defaults moving forward. 

    Immediate Impacts of Office-Loan Defaults on the Market 

    Economists are not yet sure of the degree to which falling office property values and the rising number of office loan defaults will ripple through the rest of the market. Luckily, banks are in more robust capital positions than during the 2008 financial crisis and have more capacity to weather turbulence. However, office loan defaults are expected to impact investor sentiment around office projects and could lead to a decrease in the availability of capital. Economic uncertainty and a high-interest rate environment is already leading to stalled capital deployment, making projects more difficult to get off the ground in the foreseeable future. 

    As a result, developers may need to explore alternative financing options to get projects off the ground. Government funding programs designed to boost housing production, such as Transit-Oriented Community Incentives or Low-Income Housing Tax Credits (LIHTC). Developers interested in sustainable development projects can also take advantage of green financing. Lenders looking to reduce their carbon footprint and hit Environmental, Social, and Governance (ESG) goals have created loan products designed specifically to fund green buildings meeting regional or national sustainable building definitions. 

    Establishing a robust market research and due diligence process for upcoming projects can also help weather a turbulent market. Look for markets where demand is high and consider making investments in recession-proof asset classes or low-risk asset classes. For example, mixed-use development projects help create high-density housing in high demand areas while diversifying risk for investors by bundling asset classes. In the future, if an asset class goes into decline the way office buildings have post-pandemic, the property will continue to generate income revenue from other sources. 

    [Guide] Discover how your firm can cut development costs by 2-6% in less than  12 months.

    Long-term Impact of Office Loan Defaults 

    The ongoing office vacancies and the rise of loan defaults could have a broader impact on your team’s long-term strategy. Defunct Class B and Class C office assets are contributing to a rise in adaptive reuse projects. By converting distressed office space into residential housing, developers can make a project profitable without needing to level the property. Zoning and building code regulation poses an obstacle to conversion projects, but governments are increasingly looking to loosen these restrictions to further bolster housing production. 

    Major development firms have had great success converting unused office space into housing. Developers in Los Angeles turned an unused former-Texaco office into an amenity-rich housing complex called The Crosby, and many more of these projects could occur in the city. A think tank known as Rand Corp identified 2,300 unutilized office or hotel properties that could be eligible for conversion, with the majority of aging office assets sitting vacant. Other cities are also eyeing adaptive reuse projects, The Financial District in Manhattan has been a major site of adaptive reuse, where more than half of offices were sitting empty following the pandemic .As offices were repurposed and residents began to move in, new businesses in the form of retail, grocery stores, and even schools have also emerged in the neighborhood. 

    Firms are also sometimes opting to see the low cost of office buildings as an opportunity, using the cash saved on debt to refurbish buildings with new amenities for employees that could lure tenants back to properties. In some cases converting offices into amenity=rich coworking spaces or “envy offices” could also help revitalize an imperiled asset and boost revenue. Evaluating your portfolio’s capacity for risk can be a good practice before opting to repurpose an office space, as well as assessing the demand for amenity-rich office space in your chosen market. 

    Leveraging Technology to Navigate Market Shifts 

    Embracing technology and leveraging data can help your team make decisions about your portfolio as office vacancies and loan defaults impact the industry. Modern real estate development software can help you make data-driven decisions during early-project planning. Early-project decision making too often relies on gut instinct; informal phone calls, and ad hoc historical project data. One missed scope item can end up costing your project thousands, if not millions, of dollars. Leveraging your historical and vendor data to make informed assumptions when compiling project budgets can help you ensure projects come in on time and on budget. 

    Northspyre is the purpose-built, single software solution designed to reduce manual data entry, increase productivity, and maximize returns from pre-development to project completion. With the platform’s new AI capabilities, you can further supercharge your development process. Northspyre’s AI Budget Budget Planner estimates how much you can save based on a growing vendor database. Users of Northspyre’s Bidding platform will also be able to harness generative AI to review incoming bids and from vendors to identify and missing scope or scope gaps. 

    Download our ebook How to Cut Development Costs by 2-6%” to learn more about transforming your project delivery approach, increasing returns, and gaining an edge on the competition. 

    How to Cut Development Costs by 2-6% In Less Than 12 Months Guide


    Other posts you might be interested in

    View All Posts

    Subscribe to our Newsletter

    Never miss a real estate development beat.