Interest rates and the fallout from the COVID-19 pandemic are changing the nature of the commercial real estate market.
Since the COVID-19 pandemic, how and where we work has changed. Many employers pivoted to remote work in 2020 and in some cases did not return to in-office work. The work-from-home and hybrid work trends have allowed families with young children to be more active in their children’s lives and in their home lives. More people have been able to relocate, without concern for where their employers are located.
Even though many employers are slowly returning to the office, decreased office work overall has led to a number of office building vacancies. According to Deloitte, an international business consulting firm with operations in Cleveland, office space vacancies are up not just nationally, but also across the world. Office spaces in both suburbs and cities are affected.
In the big picture, what occurs is a cascade with many consequences. Many of these consequences are bad, some are good, all are interesting.
When office spaces are vacant, landlords lose income. This makes it difficult for landlords to pay their bank loans and property taxes. In addition, many landlords will find themselves unable to re-finance or pay off their short-term, fixed-rate loans due to the current interest rates, which are at the highest they have been in 15 years after sitting at historically low levels for a very long time.
This combination of factors can lead, and has led, to foreclosures.
Further, if a landlord does not have enough money to pay taxes on their property, or to pay off a bank loan, maintenance may suffer. This can cause buildings or office conditions to deteriorate. If a building is deteriorating, the landlord could potentially be failing his duty of care to his tenants; the tenant possibly could, after consulting with an attorney, vacate without penalty.
Additionally, some office buildings are decreasing in value. The New York Times reported this month that a recently-sold office building on West 50th Street in Manhattan decreased in value by 97.5% from the time it was purchased; it was purchased for $332 million in 2006 and sold at auction for $8.5 million at the end of July.
To avoid such a situation, Cleveland is a notable example. Many local commercial building owners have chosen to convert their office buildings into living spaces.
The Washington Post notes that developers here, starting as early as 2016, have been converting office spaces around Public Square, into residences. The WaPo article states that while there were 40 apartments around Public Square in 2016, there were more than 1,200 in 2023. Downtown Cleveland buildings that have been converted include: The Standard, Terminal Tower, The May, 55 Public Square, and 75 Public Square.
Absent a lease clause regarding conversion, tenants have a right to remain in their leased space until the lease ends, or they could try to negotiate a potential owner buyout of the lease. Although professionals, owners, and tenants alike sometimes handle these problems themselves, doing so is a mistake.
As always, it is helpful for prospective owners, landlords, and tenants to consult with a knowledgeable and experienced commercial real estate attorney when entering into real estate negotiations and contracts.
This article originally appeared as a column for the Cleveland Jewish News.