Plans by federal and state governments to shrink their office holdings are creating new challenges for the already troubled office market.
In February, the federal government announced its intention to terminate nearly 1,000 office leases nationwide and sell 443 buildings, including 62 in suburban Maryland. The Trump Administration subsequently walked back those specifics. However, the Department of Government Efficiency has reportedly cancelled more than 700 leases since then, totaling 9.6 million square feet.
Meanwhile, the state has announced plans to sell nearly a dozen buildings, including the William Donald Schaefer Building and parts of the State Center complex. The state also aborted its plan to lease 45,000 square feet at 300 E. Lombard Street and began searching for 28,000 square feet of office space elsewhere.
“Obviously, it’s a scary time for a lot of people, including people in our industry. To add more square footage to the office marketplace is scary,” said Scott Wimbrow, President and Principal of MacKenzie Commercial Real Estate Services.
In addition to pushing up vacancy rates in the Central Business District and other submarkets, government downsizing could make it more difficult to sign leases with private sector tenants. Many companies are seeking out more vibrant areas. They are also growing more cautious of doing business with property owners who might be facing financial challenges, Wimbrow said.
“These issues are going to primarily affect the city,” said Terri Harrington, Managing Principal at Harrington Commercial Real Estate Services. “Vacancies from any buildings given back by the federal government in the suburbs will make it even harder for downtown owners who will be competing with buildings in the county.”
A self-described “eternal optimist,” Wimbrow believes the office market will reconcile in time. “I think the federal government has gone too far, made too many cuts too quickly,” he said. He expects government will have to rehire staff or expand contracting to carry out core services.
“To attract those employees, they are going to need pretty nice, Class A office space,” Wimbrow said. However, “landlords are not going to be as flexible with government leasing as they have been in the past. Government leases used to be golden. Obviously, not so much anymore. Government will have to pay a little more for office space. It won’t get its typical discount.”
Resolving the challenges in the office sector could be a prolonged, disruptive and difficult process.
“We are marketing some office buildings for sale and we are finding there’s fear among investors that there is this problem baked into the pie that we simply have too much office space,” said Chris Kubler, Principal, Capital Markets with KLNB. “There’s not a lot of excitement about buying office buildings that are already partially vacant and suffering from the slow bleed we have been seeing in the office market over the last few years.”
Some government buildings, which are expected to go up for sale, are also antiquated and in need of overdue maintenance or upgrades.
“I think the state is going to be frustrated to find the pool of prospective buyers for its buildings is likely going to be very small,” Kubler said.
Challenges in the office market and falling valuations for office buildings create some opportunities and a longer range solution for commercial real estate in Maryland. But none of that will be easy.
“There’s a tremendous amount of real, current distress or upcoming distress among owners of over-levered office buildings,” said Don Schline, Senior Vice President with KLNB. Sales of those properties “could provide opportunities for folks to acquire buildings at lower values. We call it a basis reset trade and it can help the market get to where it needs to be more quickly.”
Lower purchase prices could enable subsequent owners to complete deferred maintenance, renovate space, repurpose buildings or completely redevelop properties.
“I think, in general, office owners are going to have to get creative and look for options other than office tenants for income,” Harrington said. “A thought: Trump wants to increase manufacturing and, over the decades, we have converted manufacturing properties (Tide Point, Coca-Cola, Montgomery Park) into office. Can we, the state, attract business and turn those office buildings back into manufacturing facilities?”
Long-term, viable solutions for excess office buildings hinges on “understanding what the building wants to be now, how it can be revitalized or redeveloped,” Schline said. “In some cases, that’s a residential conversion. In some cases, it’s demolition and redevelopment into a host of other property types.”
For example, “we’re out on the market with three different office buildings in Maryland right now – one wants to be torn down now, one wants to be torn down eventually and the third is leased for a while to the federal government,” Kubler said.
While there is some interest among owners and investors in repurposing excess office buildings, those projects face large challenges.