As the country continues taking steps toward post-pandemic normalcy, the future of the office sector continues to be a question mark for mortgage brokers and lenders alike. The COVID-19 health crisis poses risks to traditional office life and return-to-work plans.
One thing seems clear: The post-pandemic era will be a catalyst for change in the office sector. Whether this means modifying office plans to accommodate social distancing and larger common spaces — or on the flip side, downsizing due to an increase in remote employees — flexibility in design as well as financing solutions will be critical.
Given this need for flexibility, it’s no surprise that an increasing number of industry participants are turning to bridge loans, which provide short-term funding (typically one to three years) for properties in a transitional or seasoning phase. Such loans can be particularly useful options in the continually changing COVID-19 environment.
The office sector is facing many challenges, including an apparent glut of space. Since the start of the pandemic, tenants have given back about 200 million square feet of space. The U.S. office-vacancy rate in August 2021 stood at 16.2%, matching the peak of the financial crisis of the late 2000s, according to a GlobeSt.com report.
Despite such headwinds, lenders that write off the sector entirely will be missing out on potential pockets of growth. For those willing to look beyond short-term challenges and broad generalizations, there are several positives that could ultimately boost the long-term potential for office space. Lenders that take a prudent and highly selective approach based on specific property fundamentals can continue to find attractive opportunities in the office sector.
A closer look at these trends reveals more cause for optimism than headline risks would suggest. First and foremost, there’s the question of remote versus in-office work. Will the remote model reduce the need for space? While the pandemic may have normalized a work-from-home structure, new guidelines for employees that return to the office suggest that the typical post-pandemic office layout won’t necessarily be smaller. There may actually be a reversal of the pre-pandemic “densification” trend where companies were looking to minimize an employee’s square footage.
Today, employees are looking for more space and common areas, which could mean overall demand for office space will be neutral or potentially positive — despite remote or hybrid office plans. Some sales and leasing brokers have anecdotally shared that demand for office space and the associated price points are much better than generally believed, although time will tell how this will unfold.
Furthermore, there are certain population trends that support renewed interest in the office sector within specific regions. For example, there is a key difference between dense urban markets and suburban areas. There’s a lingering reluctance to return to the office in cities with greater transmission risks due to mass transportation, busy lobbies, high-rise elevators and close working quarters.
Suburban office markets, however, have generally been quicker to embrace back-to-work trends and have seen an overall boost in occupancy during the past 18 months. As the huge demand for single-family rental housing in the suburbs would suggest, there’s continued appetite for movement out of cities that will drive demand for suburban office space.
On a national scale, there also are demographic shifts affecting office demand in certain parts of the U.S. For example, many states in the Southeast and Southwest regions have benefited from positive mitigation trends and corporate relocations since early 2020. The most publicized examples of this include the notable migration of some New York-based financial firms to Florida and the wave of California-based tech companies relocating to Texas, which has spurred increased demand for office space in these areas. There’s a fairly strong consensus that the markets with population inflows will be revived due to a larger workforce.
Lastly, the U.S. economy has seen rising consumer prices across the board over the past few months, which could suggest a longer-term inflationary environment. This has already played out in increased construction and land costs, which may force rents for all types of commercial real estate to trend upward.
Bridge loan advantage
No matter how these trends play out, this will be a time of change for the office sector. And flexibility in financing will be crucial to future success. This is why bridge loans are an ideal mortgage option in this time of uncertainty. By their very nature, these loans accommodate an interim business plan to achieve an ultimate exit through permanent financing or a sale.
Bridge loans provide more optionality for decisions to scale, recapitalize, reformat or modify property characteristics. Such flexibility is useful across all property types, but it’s particularly beneficial in the office sector, which has the potential for widespread change. Over the past few months, there has been markedly increased demand for bridge loans in more volatile sectors such as office, retail and hospitality.
Furthermore, bridge loans can be strong options for property owners struggling to obtain traditional long-term financing, whether due to COVID-related market stresses or tightened bank-loan restrictions. Federally regulated lenders may have limitations when providing permanent financing to borrowers that have missed payments during the pandemic, but alternative lenders can work with borrowers to develop more customized, short-term solutions.
Looking beyond assumptions
It is true that current spreads for bridge loans are somewhat wider in the office space than for the highly favored apartment and industrial sectors. Still, given the remaining unknowns of the pandemic, mortgage brokers and their clients can seek out a lender that’s open to looking beyond broad, sector-specific assumptions to work with them on a fair interest rate.
Factors that could be critical to determining financial terms include how the asset competes in the market, local demand drivers, the sponsor’s experience, and the current strength and historical levels of occupancy. Commercial mortgage brokers can secure a loan on a floating-rate basis, indexed to benchmarks such as the London Interbank Offered Rate, which provides added flexibility.
Looking ahead, as the U.S. continues along the uneven path to recovery, bridge loans will continue to serve as an ideal debt structure for property owners across multiple asset types who need customized financing amid this period of uncertainty and instability. It will likely take several years for the commercial mortgage industry to fully realize the impact of COVID-19 on the ways that people live and work, but bridge loans (by design) serve as an ideal, short-term solution as these trends play out.
This is a time when many lenders have remained hesitant to work with potentially challenged assets such as office properties. But a renewed look at positive office-sector trends and a careful consideration of property fundamentals could uncover solid opportunities for property owners and their broker partners. ●