Atlanta’s office market is resetting. That creates pain and opportunity

Commercial foreclosures in Atlanta remain relatively rare, primarily because many lenders are reluctant to absorb the hit to their balance sheets by taking back properties that might be worth a fraction of what they once were, observers say. Some office owners have decided they’ve endured enough, selling their buildings for pennies on the dollar. Cash-flush investor groups, meanwhile, are looking to pick up bargains hoping later to sell high.

Many of those trends were birthed by the COVID-19 pandemic that upended the economy in 2020 and were later exacerbated by the Federal Reserve’s subsequent war on inflation. Most new office buildings have weathered the storm, but older properties have dragged the rest of the market to depths not seen since the Great Recession.

The years of turmoil have brought one question to the forefront for everyone working in metro Atlanta’s office market: Are we at the bottom yet?

It’s a question only hindsight can truly answer, but the decisions office lenders and borrowers make in the interim will be the difference collectively between billions of dollars worth of profit or losses.

“It’s going to take some time for all the distress to work its way though the system,” said Patrick Gildea, a vice chairman at CBRE and co-head of its U.S. office capital markets division.

Nationwide, foreclosures are on the rise. From April to June, about $20.5 billion worth of commercial properties, but mostly offices, were foreclosed or seized, according to data provider MSCI. It’s a 13% increase from this year’s first quarter and the highest quarterly figure since 2015, the Wall Street Journal noted.

Credit: Miguel Martinez/AJC

Credit: Miguel Martinez/AJC

Real estate experts who spoke with The Atlanta Journal-Constitution said players across the region’s office market have been in a state of denial. The phrase “extend and pretend” has become commonplace — just as it was in the aftermath of the Great Recession — as lenders provide distressed debtors more time for underperforming buildings to rebound.

Brian Olasov, executive director of financial services consulting at law firm Carlton Fields, compared it to the five stages of grief.

“It starts with denial, and it ends with acceptance,” he said. “We’re still in the (bargaining) phase right now, so we still have a ways to go.”

‘Falling knives’

An office building is only worth what someone else is willing to pay.

For many of metro Atlanta’s workplaces, that number has been steadily declining as vacancy rises and distress increases. A shaky tenant base, an outdated interior or a problematic loan can tank a building’s prospects, and several properties across the region face all three.

“We’re dealing with falling knives that no one wants to catch,” said Henry Lorber, a distressed real estate expert with Henry Lorber and Associates.

For five financial quarters in a row, the amount of available office space in metro Atlanta has broken records. The region ended June with 32.6% — roughly a third — of all office square footage empty or otherwise available for rent, according to CBRE. Leasing activity has increased this year — providing a glimmer of hope that the bottom is near — but it hasn’t been enough to counteract companies that are shedding their unwanted office space.

The issue ripples beyond the fortunes of office landlords. Fuller office buildings are worth more than emptier ones. Falling property values in the commercial sector can hurt local and school tax bases, meaning other taxpayers will have to share a bigger burden to fund services or see service cuts.

Those hit the hardest have been older buildings, often called Class B or Class C. Erich Durlacher, a creditors’ rights and bankruptcy attorney at Burr & Forman in Atlanta, said it’s incredibly tough for owners to find success marketing aging office space, especially in less desirable neighborhoods.

“If you’re in downtown or a Class B or C building, forget it,” Durlacher said. “With decreased demand, every candidate and every company is trying to rationalize their footprint and minimize their occupancy expense.”

Offices need tenants to generate cash flow, and buildings hemorrhaging occupancy that are backed by debt can quickly run into trouble, especially with heightened interest rates.

Most commercial loans are what are known as balloon loans with adjustable mortgage rates. Borrowers typically pay mostly interest during the term of the loan with the bulk of the debt due at maturity.

In an attempt to stifle inflation, the Federal Reserve began aggressively hiking interest rates starting in March 2022, affecting how much interest borrowers must pay on adjustable loans. Modest rate cuts are anticipated this fall, but many real estate analysts said the pain is already being felt.

As of early August, Trepp data showed seven loans backed by 16 Atlanta area properties were delinquent, combining for $389 million. Trepp analysts said that problem could get worse because 16 office loans that total nearly $414 million are set to mature by the end of 2025 in metro Atlanta, of which 4.3% is currently delinquent.

Durlacher said a high number of defaulted loans means there are likely several landlords who are prepared to hand over their keys.

“You have someone who’s trying to hand back the keys, and sometimes you have (a lender) who says, ‘Well, I don’t want the keys,’” said Durlacher.

Bargain hunting

Building owners squeezed by loan payments or watching their asset’s value plummet have two options: Try to ride out this storm or cut their losses.

Several office owners are opting for the latter, deciding to sell their buildings for significantly less than they paid for them.

Canadian investment giant Manulife Investment Management in July sold the 24-story Proscenium office tower near Colony Square in Midtown to Atlanta-based Cousins Properties and New York-based Town Lane for about $83 million. That is 43% less than the building’s last sale seven years ago, according to Fulton County property records.

Will Yowell, a vice chairman at CBRE in Atlanta who helped broker the Proscenium sale, said the building’s vacancy rose after a few tenants declined to renew. He said that’s an issue facing many buildings, even those in desirable parts of the metro.

“Leases start to roll over, and you start to see these tenants moving out,” Yowell said. “Hence the cash flow starts to dry up for those buildings, and they can’t service the debt.”

OA Development founder Steve Berman said his firm also snagged an office complex in Gwinnett County last month at a 25% discount. His company acquired the three-building Sugarloaf Corporate Center, which is 88% leased, at about $32 million from Texas-based Velocis.

Credit: Courtesy OA Development

Credit: Courtesy OA Development

On a price per square footage basis, Berman said the Gwinnett office park sold for less than an industrial park near Hartsfield-Jackson International Airport that was nearly empty.

“There will be people wondering, ‘How did I miss those deals?’ in two years,” Berman said of the office project.

Credit: Courtesy OA Development

Credit: Courtesy OA Development

When foreclosures or sales under duress prompt office values to starkly decline, it’s called a market reset.

“(A reset of values) sounds bloodless, but it’s not,” said Olasov with Carlton Fields. “... It’s very painful. That means a lot of people, borrowers and lenders, are going to lose a lot of money.”