Workspace rides suburban office tailwinds in wake of $1.3bn CMBS loan extension

Workspace Property Trust, a real estate investment trust focused primarily on the suburban office sector, achieved a key milestone in early July when it was able to extend $1.3 billion of maturing commercial mortgage-backed securities debt.

The Boca Raton-based REIT secured a two-year extension on the debt for two key reasons, according to co-founder and chief operating officer Roger Thomas.

The first is the relative strength of the suburban office market, which for the first time in more than 30 years is outperforming downtown and central business district office markets. The second is that the REIT was able to pay down a portion of the debt and bring in new equity as part of its negotiations with special servicer Cleveland, Ohio-based Key Bank, Thomas said.

“We believe the market will continue to recover over the next six months, albeit with the potential for a modest recession,” Thomas said. “The bondholders and the special servicer agreed with that assessment, and we were able to achieve the extension.”

Portfolio snapshot

The CMBS loan is backed by a 146-property portfolio of nearly 10 million square feet of suburban office, light industrial, research and development and flex properties in 14 major US markets which include Atlanta, Philadelphia, Dallas, Charlotte, Tampa and Phoenix. The REIT also owns another 9 million square feet of Class A office properties totaling 59 properties across the US, Thomas added.

The market today is similar to the market that Thomas and his partner, Workspace’s co-founder and chief executive Thomas Rizk, saw when they were part of the management team at Cali Realty Corp in the early 1990s. The company, after it completed its initial public offering, became Mack-Cali Realty Corp.

“While there was a quiet period after the IPO, the suburban office market came out of that time on fire, and we achieved a 90 percent occupancy rate on our entire portfolio and returns of 30 percent or higher for our shareholders annually over the next five years. I believe we will see those same conditions for suburban office, possibly starting at the end of the first quarter of next year,” Thomas said.

Year-end 2022 data from CBRE shows that nationally, suburban office outperformed CBD office on several metrics, including vacancy, net absorption and rent growth.  The national vacancy rate for suburban office was 17.2 percent at the end of 2022 versus 17.6 percent for central business districts.

“There are significant differences between these markets. For the first time since 1989, there is a lower vacancy rate in suburban office markets versus urban office markets,” Thomas added.

Suburban office properties saw 0.3 percent absorption in 2022, compared with negative net absorption of 0.2 percent in downtown office markets. Finally, year-on-year rent growth for suburban office properties was 1.6 percent versus 0.6 percent for downtown and CBD markets, CBRE found.

Getting the deal done

Stronger fundamentals for suburban offices helped in the REIT’s conversations with KeyBank, the special servicer on the loan, Thomas said. The REIT also worked with Iron Hound Management, a New York advisory, on the extension.

“It is a challenging market out there, but you have to remember our portfolio wasn’t in default.  This wasn’t a situation where we weren’t meeting the metric and had to do a restructuring. The material terms of the loan stayed the same, we just achieved a two-year extension,” Thomas said.

Thomas also cited the strength of the underlying portfolio, its management team’s experience in the sector and migration toward suburban offices that began prior to the covid-19 pandemic.

“Between 2019 and 2023, suburban markets captured more than twice the number of corporate headquarter relocations versus downturn. Also, interestingly, suburban markets captured just about 50 percent of corporate relocations from companies that were located in downtown markets. We are seeing a changing of the guard for suburban office,” Thomas said.

There were other factors at play as well. “We had a fairly significant capital inflow that was contributed by our existing investors,” Thomas said. “We had other outside investors interested in contributing but our existing investor group want to do that itself.”

The money was used to pay down what Thomas said was a “relatively modest” portion of debt, with additional proceeds used for leasing and working capital for the REIT’s balance sheet. “We are well-positioned for the next two years to do what you have to do in today’s market, like building pre-built space and adding amenities,” he added.

The process of negotiating the extension was relatively straightforward, Thomas said.

“This was our first time working with a special servicer and it was orderly, and we got through the process quickly,” Thomas said.

Looking ahead

Thomas is expecting to see positive fundamentals for suburban office in the near-term.

“All of office gets painted with the same brush, but when people are talking about doom and gloom, they are referring to the downtown or CBD markets. It is a tale of two cities; there are true Class A office buildings that are doing well, but then there are the B and C assets that are having a difficult time. Part of what we are looking to do is get the story out that all office is not similar,” Thomas said.

Bigger picture, a key theme the REIT is following is a migration of people leaving cities for the suburbs.

“The pandemic accelerated that flight out of the city,” Thomas said. “We are now seeing employers say, ‘We’d like you to come back to the office.’ But they are also hearing bigger complaints about the length and cost of commutes, which is causing corporate America to look at suburban offices and say, ‘We want you in an office, but we don’t necessarily want you to commute into city.’”

The future will likely be closer to a hub-and-spoke model, Thomas said.

“Most owners are anxious to have people back in the office to reignite productivity that has been lost. We will see an evolution of the big companies maintaining a presence in the gateway and major metro areas, but I think they will have a smaller footprint and will have satellite offices,” he said.