Putting a Price on Office Uncertainty

By: Mike Leahy, Matthew Mowell & Dennis Schoenmaker, Ph.D. CRE?

Financial regulations limit the amount pension funds can invest in below investment-grade (less than Baa3 for Moody’s and BBB- for S&P) fixed-income assets. These assets, often called junk bonds, have high yields but with a greater risk of default. In fact, any bond with an S&P rating of CCC or less is considered extremely speculative, and an index tracking such bonds had a yield of 13.2% as of December 18, 2023.

Interestingly, CBRE’s latest Cap Rate Survey shows sobering, double-digit yields for Class C offices that exceed junk bond levels. Specifically, central business districts as diverse as San Francisco, Minneapolis, Houston and Philadelphia have highly challenged office properties that are estimated to trade at a 15% cap rate, or higher.

Of course, property values are difficult to estimate in today’s illiquid market but cap rates anywhere near 15% suggest these assets have become the equivalent of junk bonds in the sky. On the upside, just a few things have to go right for 15% cap rates to translate into very attractive IRRs, and such high yields may attract capital from hedge funds and other risk-tolerant investors.

Figure 1: Office Uncertainty in Context

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