The national office report published by CommercialEdge in May 2024 paints a picture of ongoing distress for the sector. In particular, the commercial real estate platform lists declining debt service coverage ratios — a means of identifying a property’s capacity to cover its debts — which indicate ongoing struggles for office properties to remain profitable. At the same time, potential interest rate cuts on the horizon may bring some marginal relief to the market, and quality assets continue to net impressive sale prices even as sales volume continues to decline.

Debt Service Declines Amid Steep Interest Rates & Dropping Cash Flow

Predictions relating to office distress since the COVID-19 lockdowns and adoption of remote work are mostly yet to materialize. Even so, CommercialEdge noted declining debt service coverage ratios (DSCRs) as a source of potential distress in some markets. A DSCR is calculated by dividing net operating income by current debt obligations, and lenders typically require a ratio of 1.25 or above, which indicates better financial health and ability to fulfill debt obligations. Meanwhile, a DSCR of 1 indicates that a property has exactly enough income to pay off its debt, whereas ratios below 1 represent negative cashflows.

Across the office sector, higher for longer interest rates have led to growing debt costs, simultaneously as cash flows have been affected by rising vacancies from companies downsizing office footprints.

So, using aggregated and anonymized income and expense data, along with researched loan information and vacancy rates, CommercialEdge estimated market-wide average DSCRs for several metros. In March, five of the 91 markets studied by CommercialEdge had average DSCRs below 1: Brooklyn, N.Y., at 0.81; Oklahoma City at 0.89; Chicago at 0.90; El Paso, Texas, at 0.92; and Cleveland at 0.96. Additionally, eight more markets averaged DSCRs between 1 and the 1.25 minimum required by most lenders. These included Manhattan, N.Y., at 1.05; St. Louis at 1.16; and Nashville, Tenn., at 1.25.

It’s worth noting that these DSCRs are only estimates and represent market-wide averages, meaning that many properties in markets with low average DSCRs still perform well even as high-DSCR markets face distress.

D.C. Records Largest YTD Sales Volume at $937 Million

The divide between high- and low-quality properties is also evident in transaction data with top-tier assets still landing high-sale figures. As an example, the eight-story, LEED-Platinum 24th at Camelback I in Phoenix sold for $86.1 million, marking the metro’s largest sale since 2022. Still, the sale price represents a discount from the $100 million it traded for in 2018.

However, the largest market-wide sales volume was recorded in the Washington, D.C. office market, which was greatly boosted by the $339 million purchase of the Central Place Tower in Arlington, Va., back in February. Then, Dallas had the second-highest sales volume nationwide at $357 million. It was followed by Phoenix ($349 million) and Manhattan, N.Y., ($290 million). Lastly, although they recorded significantly lower sales volumes of $101 million and $188 million, respectively, San Francisco and Austin, Texas, had the highest prices per square foot at $407 and $401 per square foot, respectively. Nationally, sales totaled just under $7.5 billion year-to-date as of April 2024 for an average price per square foot of office space of $157.

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For more information, check out CommercialEdge’s full office report.