The office sector's challenges continue to be pronounced, with increasing vacancies, heightened tenant improvement costs and waning rent growth tempering investor interest. Initial estimates of transaction volume in 2023 suggest that a little less than $35 billion traded hands last year, a level reminiscent of the post-Global Financial Crisis recovery.

As quarterly sales volumes have dipped below the pandemic's lowest points, 2023 sales volumes fell nearly 60% below 2022 levels, mirroring figures from 2010. Typically, the fourth quarter concludes each year with a surge in transaction activity. Yet, the final quarter of 2023 drug in an unremarkable print with the lowest total since 2009.

The decline in larger deals has reshaped the most active buyer profile. Traditionally, institutional and REIT investors have been responsible for around 40% of acquisitions, while private buyers have accounted for a similar share. However, private buyers have now stepped to the fore, representing about half of all purchases today.

Transparency in price discovery is improving, and there is an emergent shift in investor sentiment. A select minority now appears more willing to embrace lease-up risks when the associated seller discounts are notably significant. Illustrating this trend, Reliance Management bought Gainey Center II in Scottsdale, Arizona, for $175/SF ($26.5 million) from a joint venture between Goldman Sachs and Lincoln Property Company. To provide context, this property traded at $334/SF ($50.6 million) shortly before the Global Financial Crisis commenced in 2007.

In another instance, Hempel purchased a distressed note for the 30-story LaSalle Plaza in Minneapolis from Northwestern Mutual Life at $74/SF ($46 million), which reflects a 50% plunge from its 2006 valuation.

For investors unwilling to step in at today's multi-tenant prices, there's a trend among conservative buyers towards single-tenant properties to offset near-term rollover risks. Highlighting this, The Herrick Company acquired the Huntington Tower in Midtown Detroit at $356/SF ($150 million) with a 5.5% going-in yield. A stable and appreciating revenue stream backs this investment in new construction with a 22-year NNN lease with Huntington Bank.

Regarding cap rates, single-tenant properties with credit and long-term lease durations can still register cap rates between the upper 5% and 6% range. However, as investors pivot from high-risk assets, which typically involve properties of lower quality and older construction, multi-tenant properties are experiencing the exponential effects of rising uncertainty.

Specifically, since the cap rate lows of 2021, new Class A properties with strong credit and term have seen yields rise by approximately 150-200 basis points, Class B properties by 200-250 basis points, and Class C properties or those facing occupancy and geographic challenges by as much as 300 basis points.

Going-in yields for the reduced volume of multi-tenant office transactions, excluding medical offices, have risen by over 200 basis points in the aggregate and are generally in the upper single-digits with pricing typically landing in the low $200s/SF territory.

On a look-forward basis, debt maturities present potential challenges for 2024. Around $117 billion in office loans will mature this year and another $100 billion in 2025. With delinquency rates climbing by 5.8 percentage points since December 2022, now at 7.2%, there's a possibility these could return to post-GFC levels in the next several quarters. Given rising debt costs, decreasing loan proceeds, and unpredictable demand, upcoming loan maturities will indeed test the market's resilience. However, as asset valuations come further into focus, the vast pool of capital remaining in the sector should present strategic opportunities for informed investors.

Here are several graphs illustrating the current national commercial office market in The United States of America: