CMBS Loans Coming Due and Concessions: Trouble in Washington D.C. and Beyond

In this article, you'll learn about:

• Rising delinquencies and distress in Washington D.C.’s CMBS loans.
• Significant office space financial strain and high concession rates.
• Boston facing high vacancy rates and reduced leasing activity.
• Shorter lease terms affecting landlord profitability and tenant flexibility.

Washington D.C.’s commercial real estate market is bleeding. With CMBS loans looming over the nation’s capital, delinquencies are rising, and distress rates are “worrying.”

But Washington D.C., isn’t alone in its distress. Experts had been warning about the widespread turmoil that would come with the massive wave of CMBS debt coming due this year. Now, warning signs everywhere indicate that the trouble is upon our major cities.

Office markets in San Francisco, Boston, and New York (the list goes on) are beginning to crumble under the weight of its debt. But it was similar issues landed them in the same trouble, unprepared with capital due to high vacancies. Learn why our nation’s cities are still struggling almost four years post-pandemic and the prolific issues that don’t have clear-cut answers…but they do point to opportunities for tenants.

Washington, D.C. is in Danger

As of October 2023, a concerning 11 percent of office commercial mortgage-backed securities (CMBS) loans in the D.C. area were either delinquent or in special servicing, indicating financial strain within the sector.

What adds to the unease is the distress faced by the top 10 collateralized office loans in Washington, D.C., totaling just over $1 billion and representing a substantial 4 million square feet of office space. This financial squeeze raises questions about the overall health and resilience of the office market in the nation's capital.

Delving deeper into the issue, an analysis by CMBS research firm Trepp reveals that nearly 80 percent of office loans in D.C. are labeled as "criticized," signaling significant concerns about default risks. What's intriguing is that this default risk puts Washington, D.C. on par with San Francisco, despite D.C. boasting a much lower office vacancy rate.

These numbers collectively paint a worrisome picture for the future of Washington, D.C.'s office market. But these numbers don’t exist in a void. Factors like the economic downturn, shifts in work patterns (by the rise of remote work), and other external pressures have contributed to the heightened risk of default in the office market.

And while D.C. has a lower vacancy rate than cities like San Francisco, landlords in the capital had been consistently offering some of the largest concession packages. So even though on the surface it looks like more landlords have more tenants, the cost per tenant has reduced the profit to nothing- pushing some landlords into the red.

To largely bring in long-term tenants, landlords have to make the deal too good to pass up for tenants. This means premium amenities, low rent, and overall, more generous concession packages.

Too Much Free Rent

One of the biggest factors driving the devaluation of office leases is the new standard of rent abatement.

The average free rent in Washington, D.C., surged to a significant 26 months in 2023.

Another key factor contributing to the higher concessions is the average Tenant Improvement Allowance (TIA), which reached $155 per square foot in 2023. TIA represents the financial assistance provided by landlords to tenants for customizing or renovating their leased office spaces. The notable increase in TIA underscores the competitive nature of the market and the willingness of landlords to invest in tenant improvements.

Rents in DC have largely stagnated. And while there is still demand for Class A properties, the trophy segment, representing premium office spaces, has seen a moderation in concession offerings. This indicates a nuanced adjustment within specific market segments, potentially influenced by increased demand or competitive dynamics among premium office spaces.

Trouble in the Northeast

Boston is also grappling with similar challenges. In Boston, the average free rent in 2023 stood at 7.4 months, accompanied by an average Tenant Improvement Allowance (TIA) of $109 per square foot, as reported in the third quarter of the same year.

The rise in concessions in Boston has coincided with a 17.5 percent drop in leasing velocity between the second and third quarters of the year. Leasing velocity refers to the rate at which office spaces are being leased, and the decline signals a slowdown in this crucial aspect of the real estate market.

The current availability rate in the Greater Boston area stands at 20.6 percent. This figure represents the proportion of vacant or soon-to-be-vacant office spaces in the market. The 20.6 percent availability rate is the highest since the Great Recession, indicating a substantial surplus of available office spaces.

Similar to Washington, D.C., Boston is navigating a landscape where landlords are adjusting their offerings to attract tenants, but this has not necessarily translated into sustained demand or decreased vacancy rates.

The Push for Shorter Lease Terms

Another factor diminishing landlords' profitability is the growing preference among tenants for shorter lease durations.

The desire for shorter lease terms reflects a broader trend where tenants prioritize flexibility in response to evolving business needs. The dynamic nature of modern businesses, influenced by factors such as market volatility and changes in work patterns, has led tenants to seek leases that allow for quick adaptation to their spatial requirements. 

Additionally, as property valuations continue to drop, tenants become hesitant to commit to leases that might result in overpayment for the space. The overall decrease in property values influences the negotiation power of tenants, who are keen on securing favorable terms in a market where they perceive lower property values.

No tenant wants to get stuck paying for a lease that they’re immediately paying over-market for.

Warnings for Tenants

On one hand, the higher concessions have provided tenants with attractive incentives, allowing them to negotiate favorable terms and conditions. On the other hand, the stagnation in rental rates suggests a delicate equilibrium where landlords are grappling with the need to remain competitive while maintaining sustainable returns on their investments.

On the positive side, there are distinct advantages for tenants, particularly those considering long-term commitments. This is an opportune moment to engage in negotiations, leveraging the market conditions to secure favorable deals. The flexibility to negotiate terms, especially in long-term leases, presents a unique advantage for tenants seeking cost-effective and advantageous agreements.

However, amid these opportunities, it's crucial for tenants to exercise caution and be mindful of the potential downside – the looming risk of landlord delinquency. The uncertainty in the market and the challenges faced by landlords, as discussed earlier, may introduce a level of risk for tenants. It's essential to strike a balance between seizing the current opportunities and staying vigilant about the potential risks associated with the evolving dynamics of the real estate landscape.

In essence, the current market offers a window for tenants to secure advantageous deals, particularly in long-term arrangements. Yet, this window comes with the caveat of being aware and prepared for the potential challenges, with the risk of delinquency being a key consideration. Tenants navigating this market must weigh the opportunities against the associated risks, making informed decisions that align with their business objectives and risk tolerance. Stay on top of the latest evolution in the CRE space, subscribe to our blog. 

However, navigating this market requires expertise and vigilance. True Tenant Reps™ are here to guide you through the complexities, helping you make informed decisions that align with your business objectives and risk tolerance. Don't miss out on this window of opportunity – connect with a True Tenant Rep™ today to optimize your leasing strategy and ensure a successful negotiation in this evolving market.