Featured in the Colorado Real Estate Journal's Office & Industrial Quarterly

The delta variant has proven to be a major curveball for office tenants who optimistically planned for a post-Labor Day return to the office. While some companies have stayed the course and welcomed employees back to their cubicles, others have prolonged their work-from-home policies indefinitely. For now, a hybrid plan is keeping the office market in limbo. Investors and lenders remain hesitant on the asset class as a whole, so much so that office is the new alternative asset product.

With capital flooding the market, lenders have flocked to COVID-19-era darlings, industrial and multifamily, driving competition up and yields way down. The year has been anything but slow on the financing side and, as a result, insurance companies have invested billions of dollars into what is largely only industrial and multifamily mortgage. Now that we’re in the third quarter, several life insurance companies are looking to pivot their existing strategy and diversify their production by investing in some higher-yielding debt. The quest for higher yields is leading them back to office. For example, a recent loan opportunity on a 50% loan-to-value stabilized multifamily asset that typically is catnip for lenders saw several groups pass due to overproduction in low-yielding multifamily loans year to date. Many lenders found themselves at 80% of their year-to-date production in low-yield multifamily loans, and have to shift focus for the remainder of the year, chasing higher-yielding loans. On the flip side, albeit not the majority, we’ve seen select insurance company players get more aggressive on 55%-60% suburban office loans. Our point here is: Lenders are willing to finance office deals – they’re just very selective. Here are some recent takeaways from deals that are getting done: 

Operational history matters.
Lenders are laser focused on operations. They’re doing deep dives into historical asset management to ensure landlords are experienced with office products and have maintained their reserves prudently.

A diversified rent roll is more attractive than ever.
From a lender’s perspective, diversification of the rent roll and rollover mitigates a lot of risk. While this has always been the case, a varied tenancy is carrying more weight today than it has in the past.

Smaller tenants are in favor.
Smaller tenants are more inclined to return to the office setting, compared to corporations, which tend to have more elaborate, large-scale plans for returning to the office. Smaller tenants are more nimble and better able to accommodate the working parent who wants to be in the office away from the distractions at home.

Medical office tenants are uniquely alluring to lenders.
Medical office remains in favor with lenders. At the onset of the pandemic, medical office was uncertain due to the rise in telehealth. However, now more than 1.5 years into the pandemic, patients have returned to the doctor’s office, proving the asset class to be somewhat recession resistant. The inelastic nature of medical services and the sticky tenancy are highly attractive to lenders.

Until investment committee members can ditch their sweatpants and Zoom meetings themselves, it will remain difficult to envision a rush to the office market. However, financing for the right office product is available and still attractive. The pool of interested lenders has shrunk, but life companies are actively quoting office loans for good operators at sub-60% leverage with a good tenancy story. Likewise, debt funds flush with cash are finding good yield on value-add stories up to 80% loan to cost.