US Offices: A Safe Haven for Investors in Challenging Times

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Commercial real estate, particularly office buildings, is facing a challenging transition. Rising interest rates and a growing demand for sustainable architecture in new areas of the country are causing ripples in the sector. However, despite these challenges, real estate may still offer a hedge for investors looking for assets insulated against inflation and geopolitical turmoil.

According to Miriam Wheeler, head of Goldman Sachs’ Global Real Estate Financing Group in Investment Banking, there is currently an obsolescence issue in commercial real estate, especially in the office segment. This is due to a significant amount of legacy buildings. Neil Wolitzer, a managing director in Real Estate Investment Banking at GS, believes that the sector will attract capital from around the world in the medium term.

Credit Valuations in Commercial Real Estate

Miriam Wheeler provides insights on credit valuations in the commercial real estate market. The commercial mortgage-backed securities (CMBS) market, the most liquid market, experienced spread widening and credit contraction in the first quarter of 2022 due to the Ukraine invasion and a record amount of CMBS supply. However, there was firmness in the market in January and February of this year, partly due to reduced CMBS supply.

Miriam also highlights the regional bank market, which accounts for about 70% of overall commercial real estate lending by banks. As these banks face more regulation, there are concerns that borrowers will face higher costs and some banks may reduce their exposure to commercial real estate. This could impact the construction market, where regional banks are active.

The Office Real Estate Landscape

When discussing the state of office real estate, Neil Wolitzer distinguishes between the quality of assets. He believes that there is a 'b office' problem rather than a general office problem. Similar to regional malls, higher-quality office buildings with desirable amenities will continue to thrive, while older assets with poor amenities will struggle to retain tenants and grow net rent.

However, the office sector faces a more volatile macro backdrop compared to regional malls. The larger size of the office sector and the differences in cash flow characteristics contribute to this volatility. Neil acknowledges that it may take time for office to regain its status as a preferred asset class for institutional investors.

Miriam adds that banks and institutional capital are already concerned about their existing office exposure, making it challenging for borrowers to secure new loans for office assets.

Trends in Real Estate

Miriam Wheeler points out the preference for newer, higher-quality assets in the real estate market. There is a significant amount of legacy, old stock in different segments, particularly in office buildings. Lenders are focusing on institutional quality assets that meet the demands of today's tenants.

Neil Wolitzer highlights the importance of population and job growth centers when deploying capital into the office sector. Cities like Dallas, Charlotte, Austin, and Nashville offer attractive opportunities for real estate investments.

The Wall of Maturating Debt

When discussing the maturities of commercial real estate debt, Miriam Wheeler mentions that distress is expected around office assets, as some borrowers no longer have positive equity in these properties. Other asset classes, such as multi-family, industrial, storage, and hotel properties, have a lot of capital available for the remaining maturities. Private capital has also been raised to bridge any gaps.

Losses and the Future of Commercial Real Estate

Miriam Wheeler expects losses in the commercial real estate market to occur sooner than during the Great Financial Crisis. This is due to the significant amount of floating-rate debt currently in the market. Borrowers will have to make decisions around supporting assets sooner, which could accelerate distress in the office segment. However, she emphasizes that numerous asset classes still demonstrate strong top-line fundamentals and that commercial real estate historically serves as a good inflation hedge.

Neil Wolitzer believes that the real estate market is experiencing a period of uncertainty and volatility due to a decrease in available credit. However, he remains bullish on North American commercial real estate as a long-term investment. He suggests that, despite challenges, North America offers stability, natural resources, infrastructure, and a reasonably stable demographic, making it an attractive choice for global capital allocators.

When investing in commercial real estate, it is essential to seek advice from professionals and conduct thorough research.

Disclaimer: This article is for educational purposes only and does not constitute a recommendation from any Goldman Sachs entity. Goldman Sachs does not provide financial, economic, legal, investment, accounting, or tax advice through this article.