Midwest Office Markets Struggle, Texas Shows Resilience

Good morning,

Midwest office markets struggle while Texas shows resilience, San Francisco is finally rising from the dead, and Fortress takes back the keys on Midtown office. Let’s delve into today’s topics.

📈 Market Update

🏢 Midwest Office Markets Struggle, Texas Shows Resilience

Chicago and Minneapolis office markets are struggling with high vacancy and weak demand, while Dallas and Houston have fared better. Chicago and Minneapolis have demolished or repurposed a significant portion of obsolete office space to try to reduce supply, but still have record vacancy levels around 20%. In contrast, Dallas and Houston have low office demolition rates and are projected to regain positive absorption by 2025-2026.

The main difference is the structural vacancy rate - Dallas and Houston have historically had higher vacancy around 15%, while Chicago and Minneapolis are used to lower vacancy around 8-13%. As vacancies rise to projected 19-20% in all markets, Chicago and Minneapolis will feel more pain with a larger relative increase versus their normal levels. Lowering office valuations to attract repositioning is an option, as is further reducing supply by demolition or repurposing obsolete properties.

🌇 San Francisco Rising From the Dead?

San Francisco's office market is showing signs of life after being the hardest hit in the nation during the pandemic, with AI firms leasing large blocks of space and investors acquiring office towers at steep discounts. Recent sales at a fraction of pre-pandemic values have helped reset rents to more affordable levels, attracting tenants once priced out of the city. Landlords are now seeing heightened demand, with 4.5M SF of active requirements versus 2.5M in January. Major leases by AI companies like Anthropic and OpenAI underscore the market's increased competitiveness after the pricing reset. If the momentum continues, San Francisco's office sector could be poised for a post-pandemic rebound.

The Case for SF Hotels:
According to tourism officials, conventions face a light calendar but benefit from short lead times. Homelessness exacerbated by missing office workers is a challenge. But the city offers value for groups, with room rates up only slightly pre-pandemic. Supply, upgraded centers and easy air access remain enticing. San Francisco still has ingredients that made it a top destination. Direct experience provides a nuanced view compared to negative perceptions.

🔑 Fortress Takes Back the Keys on Midtown Office Building

The Class A office tower at 300 East 42nd Street in Manhattan is expected to sell for well under its 2019 purchase price of $122.5M after owners Somerset Partners and Meadow Partners defaulted and handed the building back to lender Fortress Investment Group. Despite capital improvements and amenities added by the owners, the property has struggled to attract tenants given its location on the easternmost edge of the Grand Central submarket. With the building underperforming relative to debt obligations in a difficult office market, the owners have opted to let go of the asset, following a common fate for office landlords amid rising rates and dim leasing prospects.

✍️ Further Reading

• CalPERS Invests $3.2B in Blackstone, Other Funds (GS)

• There is $436B of Multifamily Debt That is Potentially Troubled (GS)

• What RTO Mandate? Vacancy Rates Keep Rising (GS)

• London City Office Availability Sinks to Three-Year Low (CS)

• Robust Construction Pipeline Curbs Apartment Rent Growth Potential in Colorado Springs (CS)

• Market Pulse: Triple-Witching Friday Transforms Gains into Losses (Trepp)

📊 Chart of The Day