The Post-Halloween Scare: The Office Submarket

By Mark E. Ellinghouse

Though Halloween has come and gone, a real-life scare continues to linger: the office sector of commercial real estate. Office has been the slowest sector to recover from COVID, as companies wrestle with remote/hybrid work policies in determining their future office needs. While some businesses have relinquished their office space completely or downsized to maximize the efficiency of square footage in highly amenitized buildings, others are making efforts to bring their staff back in and negotiating the inevitable reluctance from employees who got comfortable working in their loungewear. The future of office is uncertain, to say the least.

As part of our continuing series profiling industry segments, I met with Nellie Cruz of CBRE, an office specialist, to get her insights on the commercial office market. Cruz is part of CBRE’s impressive office team in Sacramento, which has completed over 2,800 transactions on over 34 million square feet of property valued in excess of $8.8 billion in total consideration. A Sacramento native, Cruz has in-depth knowledge regarding the local market and deals with the intricacies of this sector on a daily basis.

Cruz notes that while the headlines emphasize the continuing struggle of office owners, conditions are not nearly as dire as other commentators may suggest. Modern, well-equipped buildings in downtown markets, as well as well-placed suburban office projects, are seeing steady interest from strong tenants who are eager to capitalize on a tenant-favorable market. The projects which are having difficulties are typically those buildings that are aging, lack modern amenities, or require significant investment to update floor plans or remedy deferred maintenance issues. Market issues aside, these projects are always the types of assets that struggle to compete, as tenants are willing to pay higher rent if the space offers modern comforts.

The dichotomy between these projects recently played out in two transactions in the downtown Sacramento office market. The building in which my firm has space, the Wells Fargo building at 400 Capitol Mall, was purchased by a group led by an affiliate of Buzz Oates for $117 million. The building is 92% leased and in good condition. While the purchase price did not match the most recent sale in 2019, it was a competitive figure that reflected a significant investment by its new owners. On the other hand, the Renaissance Tower at 801 K Street was sold at auction to Ethan Conrad. The asset had been in and out of contract over the past year, and sold for a paltry $21 million, a quarter of its 2016 sale price. The building is only 27% leased, features outdated office floor plates and layouts, and requires substantial improvements to modernize its infrastructure.

It’s not often that two high-rises in the Sacramento trade hands in a single month. Not only were these transactions interesting to watch from a general perspective, they were also critical benchmarks for the office market overall. Will the (relative) success of the 400 Capitol Mall sale give office holders confidence that the market is improving, or do the difficulties involved in the disposition of 801 K Street signal more headwinds ahead? Investors and managers are eager to watch this play out, as opportunities may await those that are willing to take the risk that the office market is on the upswing.

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