Sharks ‘smell blood’ in Atlanta’s office market as distress mounts

Nearly 23% of all securitized debt backed by office properties is delinquent in metro Atlanta, meaning its owner has missed at least two payments, according to Trepp data. That ranks seventh-highest among the country’s 25 most populous metros and represents more than $2 billion in distressed debt.

The depths only get deeper when you strip out only commercial mortgage-backed securities, or CMBS loans, which are a common funding tool that represents about a third of metro Atlanta’s commercial real estate debt.

Nearly 27% of all CMBS loans backed by office properties in metro Atlanta are delinquent. That’s roughly four times the distress from two years ago, a sign of mounting pressure on office landlords who have struggled to make their buildings profitable in a postpandemic world.

Atlanta’s urban and suburban office markets have grappled with record-setting vacancy rates since the COVID-19 outbreak normalized remote work five years ago. At the end of December, nearly a third of all office square footage in the Atlanta area was either empty or available as subleased space to rent, according to real estate services firm CBRE.

It’s an issue that has roiled large office markets across the country, sparking fears of widespread foreclosures and eroding commercial property values that bolster local tax rolls.

“The distress cycle is like a slow burn or a churn,” said Abby Corbett, head of investor insights at real estate services firm Cushman & Wakefield. It’s a “yearslong process that kind of chugs along, and we’re in the midst of that process,” she added.

Scores of buildings at risk of default have entered special servicing, which is when a third-party firm intervenes to try to resolve a problem loan. Some of the country’s most famous buildings have become ensnared by debt issues, such as Chicago’s Willis Tower, a skyscraper originally called Sears Tower that entered special servicing in early February on its $1.3 billion in debt.

Despite the torrent of missed payments, commercial foreclosures in Atlanta have remained relatively rare. Hagan Dick, executive vice president on the Colliers Atlanta debt and equity team, said many lenders are reluctant to absorb the hit to their balance sheets by taking back properties that might be worth a fraction of their prior values.

“Generally speaking, lenders don’t want these properties back,” he said. “If it’s coming back to you (through foreclosure), that means it’s underwater.”

In 2022, six towers and the mall within Peachtree Center, a landmark downtown office and retail development, were returned to the lender in the largest foreclosure sale in Atlanta since the fallout of the Great Recession. But most other distressed office complexes, including those advertised for foreclosure, have managed to negotiate extensions and avoid public auction. It’s a process often called “extending and pretending,” hoping extra time will reverse a building’s fortunes.

Credit: TNS

Credit: TNS

Buckhead’s largest office complex, the 14-building Piedmont Center, is stuck in loan negotiations after missed debt payments nearly led to a public auction in February. (That advertised foreclosure was postponed but could still take place in the coming months).

To stave off foreclosure, some buildings have sold for pennies on the dollar, even those in good locations or with strong tenant bases. All-cash purchases, opportunistic investment funds and other alternative financing strategies are starting to ramp up as companies and investors scavenge the sea of distress.

“There’s a lot of sharks circling when they smell blood,” Taylor said.

‘Window of opportunity’

The pandemic disrupted many industries, but it prompted fears of an existential crisis within the office sector.

It wasn’t a stretch to wonder if offices would ever look the same, and pessimists were quick to say that “office was dead.” As leasing activity cratered and interest rates rapidly increased to counteract inflation, office quickly became a four-letter word among banks and traditional real estate investors, said Mark Toro, a developer who helped build the popular Avalon project in Alpharetta.

But there’s a reason “zig when they zag” is a business cliche, since sometimes the largest profits are found by cutting against the popular grain.

“The first movers out of this nuclear winter are going to be the winners,” Toro said.

Atlanta-based Cousins Properties, the largest office owner in the city, has emerged as an aggressive office optimist, and CEO Colin Connolly is backing up that conviction with splashy building purchases.

Cousins scooped up the Proscenium tower in Midtown through a joint partnership at a 43% discount last summer. During the fourth quarter, it bought other high-end office towers in Charlotte, North Carolina, and Austin, Texas, investing nearly $1 billion to acquire the trio of office complexes at a time when most banks are trying to shed their office exposure. Instead of traditional debt, the company sold stock to help finance those acquisitions.

“There’s not a lot of private debt or equity available for office, and when it is, it’s quite expensive,” Connolly said. “It creates a window of opportunity for a well-capitalized company like Cousins that does not have to rely on any outside capital for debt or equity to take advantage of interesting investment opportunities.”

Credit: Courtesy CoStar

Credit: Courtesy CoStar

Will Yowell, vice chairman with CBRE’s Capital Markets Institutional Properties Group in Atlanta, said those type of transactions are the kind that sparks “investor FOMO,” the fear of missing out. While some buildings have larger issues than just their debt, especially older offices and those in poor locations, Yowell said there are opportunities out there.

But it’ll take time — and likely a lot of foreclosures and distressed sales — before the traditional debt markets jump back into the office pool.

“The investment world doesn’t really work well until there’s a functioning debt market,” Yowell said.

Other firms have also sought less-common financing methods to make their projects work. Instead of using a domestic bank, Toro received a $158 million construction loan from Mexico City-based Banco Inbursa to break ground on his Medley mixed-use development in Johns Creek, which includes plans for 110,000 square feet of office space.

Credit: HYOSUB SHIN / AJC

Credit: HYOSUB SHIN / AJC

Forthcoming reckoning

While those looking to buy or invest in office buildings may soon have more financing choices, landlords who own distressed buildings are running out of options.

“There’s hope on the buy side,” Corbett said. “It’s really a reckoning on the sell side. … Sellers are increasingly realizing that they can’t just wait for lower interest rates to be the impetus for that moment to go to market. That’s not going to be the lottery ticket for this strategy.”

The deepening divide between buildings that are winners and losers has grown more stark over the past five years.

Top-quality buildings, which the industry calls trophy or class A, have much higher occupancies than their discount counterparts, often called class B. Nationwide, roughly half the class A buildings are fully leased or have less than a tenth of their space available to rent, according to Cushman & Wakefield. Another 20% of office buildings have their occupancy above 80%.

Connolly says that trend will continue to accelerate.

“Real estate that has become functionally obsolete for its underlying customer will continue to worsen,” he said. “Occupancies will go lower, and it will ultimately reprice at a level where that existing building can be either repurposed or torn down to make way for a higher and better use.”

Demolishing or converting unwanted office space into something more desirable are two ways to try to eliminate vacant space. Leasing activity is also starting to rebound after several down years, indicating employers are becoming more confident with their office needs. More employers are implementing return-to-office plans.

If office demand rebounds, high-end space could soon be in short supply. A record-low 474,000 square feet of new office space is in Atlanta’s pipeline, according to CBRE, so there will be almost no new space to spur new competition.

Credit: Miguel Martinez-Jimenez

Credit: Miguel Martinez-Jimenez

Taylor said those underwater office buildings still represent a lot of pain on the horizon for many owners, especially as lenders lose faith in “extending and pretending.” After the Great Recession of 2008, scores of Atlanta landmarks went into foreclosure. Taylor doesn’t expect as bad a situation this time.

“Because of the way the market has been structured, especially after the Great Financial Crisis, we don’t see that (delinquency) kind of proliferating through the system and causing widespread distress,” he said. “Some investors will suffer in this market, but I do see on the other side there’s a lot of opportunity.”