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January 8, 2024 Industry Outlook | Real estate

Office market faces major headwinds in 2024; isolated, premier locations could rebound

PHOTO | RED THREAD Office amenities, like a modern kitchen, are attractive perks companies are seeking out to get workers back to the office.
By Michael Puffer
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Greater Hartford’s struggling office market will continue to experience increased vacancies in 2024, as the post-pandemic shift to hybrid and remote work continues to play out, experts said.

As long-term leases struck before the pandemic continue to expire, some expect a continued “flight to quality,” as companies choose nicer, but smaller spaces.

Highly sought locations could be poised for a rebound as they attract more companies seeking vibrant work environments capable of enticing staff back to the office.

At the close of the third quarter, Greater Hartford’s office vacancy rate had climbed to 28.2%, according to brokerage firm CBRE, while 29.8% of the region’s 73.2 million square feet of office space was available, a new record high.

Here are some other trends that will impact the office market in the year ahead.

Financing woes

Michael Seidenfeld

Looking ahead to 2024, high interest rates will continue to have a chilling effect on commercial real estate, including office space, according to Michael Seidenfeld, chief operating officer of Shelbourne Global Solutions, downtown Hartford’s largest landlord.

Connecticut’s office market is “significantly at risk” as higher rates and scarce availability of commercial real estate loans make refinancing “virtually impossible,” Seidenfeld said.

Brooklyn, New York-based Shelbourne has an ownership stake in four of downtown Hartford’s 15 Class A office towers, including one property — the Stilts Building, at 20 Church St. — that fell into foreclosure in 2022. Shelbourne had been trying to refinance the property’s $31 million mortgage that was due to mature in April 2023.

The foreclosure case remains ongoing.

In the current financial climate, lenders will have to extend loans for two to five years and modify terms to help owners keep properties functioning until interest rates go down and more companies return to work, Seidenfeld said.

Unfortunately, many commercial mortgage-backed security lenders are doing the opposite, he said, and either foreclosing on properties or forcing owners to abandon them.

“The foreclosure process is a self-fulfilling prophecy of certain doom, as property values have plummeted and recoveries will be mere cents on the dollar,” Seidenfeld said. “Without a major reduction in rates, and also lenders coming back into the commercial market, there is no bright spot in this sector.”

Unrealistic municipal assessments

Seidenfeld said many municipalities will lose millions of dollars in tax revenue as vacancies increase and property values deflate.

Hartford officials have been particularly wary of this potential, given that nearly 30% of the 7.97 million square feet of office space in the city’s central business district is vacant, according to CBRE.

In 2022, Shelbourne filed more than a dozen lawsuits against the city of Hartford seeking relief from office building property assessments it argues are out of line with reality, leading to unfairly high and potentially ruinous tax bills.

“Alarming” vacancy rates will continue this year, with ongoing office space downsizing by major corporations and virtually no sales or refinancing pushing down property values, Seidenfeld said.

“This reality will translate into thousands of properties across the state not being able to sustain existing buildings and the loss of many to foreclosure or abandonment,” Seidenfeld said.

Seidenfield said the ongoing conversion of Class B office buildings of less than six stories into apartments is a great idea that helps address the state’s housing shortage. But conversion of larger Class A office towers into housing isn’t possible without substantial state and federal support, he said.

Despite its office issues, Shelbourne has continued to invest in Hartford, particularly in new housing projects. It recently launched a $42.1 million conversion of a portion of the former Fuller Brush factory in north Hartford into 155 apartments.

Flight to quality

Joel Grieco

Today’s landlords must decide to invest in their properties or reposition them for alternative use, both expensive approaches, said Joel Grieco, office brokerage executive director of Cushman & Wakefield’s Hartford office.

Office buildings that don’t see investment and attempt to compete on price alone are likely to languish until owners are forced to make a move by the market or a lender, he said.

Pre-pandemic, companies typically rented 190 square feet per employee; that number will decline to 165 square feet per employee over the next several years, Grieco said.

A smaller footprint allows companies to invest in higher-end space at newer or renovated buildings with amenities like a game room, golf simulator or outdoor fire pits, he said.

“Eventually, the remote working dynamic will flow completely through the marketplace as pre-pandemic leases expire and as firms shed the space to meet new-era, hybrid work requirements,” Grieco said.

Rising rents

Grieco said he predicts the “flight to quality” will continue over the next couple years.

However, Hartford County does not have a deep inventory of premier buildings, Grieco said. That sets the stage for rising rental rates among top-tier office properties.

High-quality buildings in the best locations with easy access to on-site and nearby amenities will be best-positioned for a rebound from the current malaise, Grieco said.

Rental rates are already picking up in the center of West Hartford and parts of Glastonbury, where demand is high and vacancy rates are low.

The dramatic recent increase in construction costs will mean higher upfront fit-out costs for landlords and new tenants, Grieco said. That means additional pressure to raise rents.

Check out the rest of HBJ's 2024 economic forecast issue

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