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Weekly Market Report - August 28, 2023

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Employers gain leverage to pull workers back, but we’ve seen this movie before


The Great Resignation, which saw millions of Americans leaving old jobs for new ones or none, has ended, and data suggests that the annual prediction of employees returning to their desks after Labor Day may be true. This time, employers have increased leverage in the never-ending back and forth with workers. A JLL study found that 2.5 million office-based employees in the U.S. will face return-to-office mandates through the end of the year. Firms like BlackRock, Meta, Robinhood, and Zoom have called their employees back into the office. The industry's argument is that productivity will be better over the long term, with the winners being the most connected, productive teams. Office occupancy is expected to increase to 55 percent to 65 percent by year-end, setting a post-pandemic record.


Offices have remained ghostly on Fridays, and even if a return-to-office surge happens, it would likely be on Tuesday through Thursday. U.S. office leasing has begun to rebound, with gross leasing volume up 11.6% from last year, the fastest growth rate since mid-2021. Select industries have been driving office demand, with leasing by energy companies and utilities growing nearly 40% year-over-year. Some employees may be prompted by their children's change in routine, as they may be prompted by their children returning to school.



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Originations sink across asset types as lenders more selective


Commercial real estate lenders are facing a wave of distress, with debt origination volumes falling 52 percent year-over-year in the second quarter. Capital markets report found 32% fewer lenders than a year ago, and lenders have become more selective due to the Federal Reserve's interest rate hikes. CMBS and collateralized loan obligations originations fell by 79% from last July, while debt fund loan originations are down 73% annually. Lending volume among banks also fell 48 percent year-over-year. The CMBS market showed some hope after an abysmal first quarter, with issuance volumes rising 57% from the previous quarter but still down 59% year-over-year. As banks and other lenders cautiously tread, commercial real estate landlords are turning to the private equity market, raising $219 billion in dry powder for equity or debt investments. It is estimated that more than half of this capital will be aimed towards multifamily assets and industrial assets, reducing office and retail assets. Borrowers are jockeying for position to be among those taking advantage of private equity deployments. One could be optimistic about capital markets in the coming year, predicting interest rate clarity and a tacit agreement on price points across asset classes between borrowers and lenders.



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Witkoff-led group bought property decade ago eyeing condo conversion


Qatar's sovereign wealth fund has acquired the Park Lane Hotel in Central Park, New York, as part of its push into New York real estate. The Qatar Investment Authority paid nearly $623 million to acquire the 46-story hotel from Steve Witkoff's company, property records show. The $450 billion sovereign wealth fund initially planned to convert the hotel into high-end condos but put the conversion on hold due to oversaturation in the Billionaires' Row market. In 2016, Chinese developer Greenland Group bought a 41% stake in the project from Kuwait Strategic Investors. However, the Justice Department filed a lawsuit to seize the hotel as part of its investigation into Malaysian businessman Jho Low, who was accused of stealing $4 billion from the Mubadala Investment Company. Witkoff put the property up for sale in 2017. However, no one met their $1 billion asking price, and the owners refinanced the hotel in 2019 with a $615 million loan from Deutsche Bank and JPMorgan. The Abu Dhabi fund increased its stake in the property as part of the DOJ's effort to recover funds. The deal represents Qatar's latest move in New York, following a $261 million preferred equity investment by the Qatar Investment Authority to finance Meyer Orbach and Josh Gotlib's purchase of three apartment buildings developed by the late Sheldon Solow.



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A record 217 million square feet of sublease space is also weighing down office values


Office landlords are experiencing an increase in lease signings this year, but the average new lease is smaller than before, indicating that companies are committing to spending less on office space for years to come. This trend is reflected in the adoption of hybrid strategies that allow employees to work more from home, leading to firms signing deals of up to 15 years for fewer office floors. In the second quarter, U.S. businesses signed new leases for an estimated 97.5 million square feet, up from 57.4 million square feet in the second quarter of 2020, the low point of the pandemic. However, the average U.S. office lease size was 3,275 square feet, or 19% less than the average lease size between 2015 and 2019.


The U.S. office vacancy rate has increased to 13.2% from 9.5% before the pandemic, and CoStar forecasts it will increase to more than 17% by the end of 2026. This shrinking lease size is another blow to office owners during one of the industry's worst slumps since World War II, which is hurting cities, wiping out billions of dollars in property values, and putting pressure on the shaky banking system. Large employers have recently sliced their office demand, while smaller businesses are leasing less space in renewals and when they change locations. Hybrid workplace policies are also contributing to shrinking space, with 61% of U.S. companies allowing remote work part or all of the week. The number of companies requiring workers to be in the office full time has declined to 39% from 49% at the beginning of the year, and this number is likely to continue to decrease as newer companies embrace flexible work practices more than older companies.



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The housing crisis in New York City has led to proposals for solutions such as converting offices into housing, permitting denser high-rises, and legalizing basement apartments. However, a residential trend is already happening in Queens, which is surging as a residential alternative to Brooklyn and Manhattan. This uptick in demand has led to a mini boom in supply, potentially producing lower rents, developers, brokers, and residents say. The housing stock increasingly resembles the high-rise, multifamily type common in other neighborhoods, and hybrid work is allowing people to live farther from the office. However, Queens is still a bargain, as rents elsewhere continue to smash records.


Developers say Queens' huge size makes those concerns overblown, as it spans from the Atlantic Ocean to the Long Island Sound and packs about the same population of Brooklyn into 50% more space. Last spring, apartment seekers more than doubled their demand from pre-pandemic levels, with 133% more searches for Queens homes in May 2023 than in May 2019. The borough's average rent is $2,800 a month, compared to $3,300 in Brooklyn and $4,600 in Manhattan. However, rents are rising in some pockets, with Long Island City and its surrounding neighborhoods experiencing a median rent of $3,600 a month in June 2022.



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Goldman Sachs is pushing for greater enforcement of its return-to-office mandates, which began in May 2022, to reduce the number of employees returning in-person full time. The company is "cracking down" on those who aren't following the policy, and senior managers are frustrated by the reluctance of other staff members. Goldman Sachs has encouraged employees to work in the office five days a week since its policy was communicated. However, only 65% of employees returned full time six months after the mandate went into effect. The firm operates office buildings in 38 countries and has over two dozen U.S. locations. The company is in the process of building an 815K SF office in Dallas, expected to cost $500M, with 5,000 employees expected to operate out of the property starting in 2027. Despite the increased number of mandates, data shows that in-office occupancy has remained around 50% of pre-pandemic levels. Analysts expect a ramp-up in enforcement, with 28% of corporate decision-makers threatening to fire employees who don't comply with office mandates.



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WeWork is seeking advice from real estate advisers to help with a restructuring due to a heavy debt load and poor financial performance. The company has hired Hilco Global, consultant Alvarez & Marsal, and law firm Kirkland & Ellis for advice on its options. WeWork's ability to avoid bankruptcy depends on whether it can terminate or renegotiate a substantial number of leases in more expensive markets. The company has been facing doubt about its ability to stay in business, with its shares dropping 97% in the last year and its debt falling to distressed levels.


The company is focusing on cutting rental costs, negotiating more favorable leases, boosting revenue, and raising money. In August, WeWork added four restructuring specialists to its board. The company's market share has come down somewhat since its peak, with 64% of its leases in Class-B and Class-C buildings. WeWork is working with Cineworld Group PLC in its Chapter 11 bankruptcy process and adding four experts in bankruptcy and corporate restructuring to its board.

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