Office loan defaults pose a high risk for major US financial districts, potentially signaling impending issues for large cities.
A new study by The Kaplan Group analyzed office building data in key US financial districts to determine which are most at risk of a large number of loan defaults or even geo-centric office firesales.
Districts at the most risk could predict which cities are at large risk of a firesale, but also which could likely repurpose their financial districts.
Key Takeaways
- Financial districts in San Francisco (.67/1), Seattle (.64/1), and Houston (.62/1) are at the highest risk of major office loan defaults of all US districts.
- Financial districts are experiencing significantly longer vacancy periods compared to the national average. While the national median days on the market is 334 days, financial districts average nearly double that at 599 days.
- Offices in the financial district in Hartford have median days on the market exceeding three years, while cities like Philadelphia, Miami, and Jacksonville are below the national median.
- The monthly rent cost for an office per square foot is the highest in the financial district in San Francisco at $4/SqFt, followed by New York ($3.83) and Boston ($3.5).
Districts that Can’t Fill Office Space
A financial district is typically a central area in a city where financial services firms such as banks, insurance companies, and other related finance corporations have their headquarters. In major cities, these districts often feature skyscrapers and important financial utilities like stock exchanges and regulatory authority offices, making them significant financial centers. They are also offering a large number of office space.
Almost all financial districts are struggling more than the rest of the country to fill empty offices. The national median days on market, or the number of days an office remains on the market before being rented, is 334 days. In financial districts, this figure nearly doubles, with an average of 599 days on market. This trend may indicate that these central city areas are losing their attractiveness.
The time it takes to rent offices varies significantly from city to city, but most financial districts require well over a year. Leading the list, offices in Hartford (1183 median days on market) need more than three years to be rented. Only Philadelphia (315), Miami (278), and Jacksonville (163) are below the national median of 334 days.
New strategies
This study analyzed various factors that could influence the longer median days on market. We found a moderate negative correlation between the median days on market and the asking rate. As the median days on market increase, the median asking rate ($/SqFt) tends to decrease. This suggests that lowering prices may not necessarily reduce the median days on market, and these offices may need to adopt new strategies to avoid remaining vacant. Additionally, our analysis found a moderate positive linear relationship between square footage and the number of available offices, indicating that larger office space may be harder to rent.
Ranking of financial district risk of loan defaults
We created a score to evaluate which financial districts are more at risk of foreclosure due to the struggle to fill empty offices. The scoring system evaluates cities based on three key metrics: Median Days on Market, Vacancy Rate in the metropolitan area, and Vacancy Rate Growth. The final score is calculated using a weighted sum of these normalized values, providing a comprehensive measure of market conditions. Higher scores indicate a higher risk for financial districts to not be able to fill empty offices.
The top three financial districts in terms of scoring are San Francisco, Seattle, and Houston. San Francisco leads with a score of 0.672 and has the highest vacancy rate among all the financial districts. Seattle follows with a score of 0.637, with the largest vacancy rate growth. Houston ranks third with a score of 0.615 with high vacancy rate and days on market.
Financial districts in Philadelphia, New Orleans, and Miami are facing the least challenges. Philadelphia has a score of 0.226, indicating relatively better market conditions compared to other cities. New Orleans follows with a score of 0.159, reflecting favorable metrics, particularly in vacancy rate. Miami ranks the lowest with a score of 0.088, showcasing the best market conditions among the evaluated cities, driven by low vacancy rates and shorter days on market.
The monthly rent cost for an office per square foot is highly dependent on location. The financial district in San Francisco tops the list at $4/SqFt, followed by New York ($3.83) and Boston ($3.5). Interestingly, these three financial districts are close to the national median days on market. Conversely, the financial district in Des Moines has the lowest rate at $1.4/SqFt but ranks third in the longest median days on market.
The analysis reveals that financial districts across the U.S. face significant challenges in renting office spaces. These findings underscore the complexity of the financial district office rental market and the need for targeted interventions to revitalize these areas.
What’s next for these districts?
Financial districts may be on the brink of significant changes. If vacancy rates remain high, we could see a wave of loan defaults or even localized firesales. However, a proactive strategy to watch for is the repurposing of office buildings. Transforming vacant office spaces into mixed-use developments or residential units could revitalize these areas and attract new tenants, potentially averting widespread financial distress.
Between the lines
San Francisco, Seattle, and Houston’s financial districts may soon see an increase in office repurposing efforts. This shift could involve converting vacant offices into residential spaces, coworking environments, or other mixed-use developments. Such transformations not only help mitigate the risk of loan defaults but also enhance the long-term economic sustainability of these districts.
What to watch
If financial districts with high vacancy rates don’t start filling their spaces, we’re likely to see a surge in office foreclosures or loan defaults. Keep an eye on lenders’ responses in these high-risk markets. Their actions could signal whether this issue will become a national trend. Additionally, watch for any movements towards repurposing buildings as a strategic response to prolonged vacancies.
This may not be a national threat
While the threat of loan defaults is real, some financial districts are already exploring repurposing strategies. For instance, cities like Miami, New Orleans, and Philadelphia are showing signs of resilience with shorter vacancy periods and lower risk scores. These areas may lead the way in demonstrating how repurposing can be a successful strategy.
More on loan default risks
For detailed guidance on preparing for rising bankruptcies and identifying early warning signs that a client might declare bankruptcy, check out my Forbes articles:
- How to Brace Your Company for Rising Bankruptcies: Offers practical steps to safeguard your business, from cash flow management to diversifying revenue streams.
- Signs Your Client Might Declare Bankruptcy And What To Do Next: Provides insights into early bankruptcy indicators and proactive strategies to manage potential financial troubles.
Methodology
Data for this study was collected from Crexi, focusing on office rentals in the main financial districts in the U.S. We chose to focus on financial districts for this study because these areas are central hubs for economic activity, housing the headquarters of major financial services firms such as banks, insurance companies, and other finance-related corporations. This focus allows us to understand the unique dynamics of office space demand and supply in some of the most economically significant parts of major cities. Correlation analysis was conducted to understand relationships between variables, and descriptive statistics were calculated to provide overall trends. City-specific analysis identified outliers in median days on market.
The risk of foreclosure scoring system evaluates cities based on three key metrics: Median Days on Market (40%), Vacancy Rate (40%), and Vacancy Rate Growth (20%). Each metric is normalized to a scale of 0 to 1 to ensure comparability. The final score is calculated using a weighted sum of these normalized values, providing a comprehensive measure of market conditions.
