Older Offices Need Major Upgrades As Baltimore Ranks Among Cities With Most Troubled Loans

Baltimore is among the top 10 cities in the country for the share of its office loans that are troubled, a new report found, but experts say there is still potential for struggling, older office buildings to rebound. 

Obsolescence Equals Opportunity, a Cushman & Wakefield report, classifies nearly 3% of outstanding office loans in Baltimore as troubled, the eighth-highest percentage of the markets it studied. However, Cushman & Wakefield experts downplayed the immediate risk of those loans to the Baltimore area's office market, despite the city having a glut of older office buildings fighting to retain tenants.   

"We want to get ahead of this," said Mike McCurdy, Cushman & Wakefield managing principal for the Baltimore region. "We have to be proactive. We can't ignore the phenomenon, but we haven't seen any impact yet."

McCurdy met with his Baltimore team in February, he said, and raised the issue of troubled loans as "a potential concern downstream." Professionals in the Baltimore office weren't apprehensive about the impact of underperforming loans, he said. 

"We're just aware that this is something that we need to be prepared for so that we can give the best advice to our clients at the end of the day," he said. 

Cushman & Wakefield's report ranked 27 U.S. markets that have at least $10B in outstanding debt by the percentage of all office loans in some form of distress. Researchers classified troubled loans as lender-owned assets, loans labeled as potentially troubled or those classified as having troubled performance.     

Orlando, Florida, ranked at the top of the list, with nearly 5% of office loans troubled. On the other end of the spectrum, researchers found struggling loans made up less than 1% of the Boston metro area's outstanding debt.     

Abby Corbett, Cushman & Wakefield head of investor insight and an author of the report, said the researchers included information on underperforming loans to highlight variations in market conditions across the nation. The percentage of distressed office loans in the Baltimore area shouldn't necessarily spook investors, she said.    

"I wouldn't say it's alarming yet," she said. "Three percent is still very low, particularly if you look at ... the historic perspectives of where we had trouble during the [2008 financial collapse]."

Yet the underperforming loans in Baltimore will be a factor to watch, especially for owners of older assets struggling to attract and retain tenants amid the flight-to-quality trend, which dominated office leasing before the pandemic but has accelerated since 2020. 

Leasing activity in the city at the end of 2022 demonstrates the ascendancy of the flight to quality in Baltimore. The year's final quarter produced what JLL's most recent market report called "a post-pandemic record-breaking quarter for leasing activity." Much of that activity was driven by leasing at trophy and Class-A waterfront buildings, JLL found. 

Deals signed last quarter at top-flight buildings included Morgan Stanley renewing an existing lease for 196K SF at Thames Street Wharf and adding 46K SF. CFG Bank inked a deal to move its offices from Towson to 97K SF at Baltimore Peninsula. 

The strong end of the year wasn't enough to offset a down year for the market overall. According to JLL, the Baltimore city market, which represents nearly 32% of the metro area's office inventory, posted negative net absorption of 263.6K SF, with total vacancy exceeding 20% last year.

Meanwhile, Baltimore's central business district, which has 11.6M SF of office space, posted negative net absorption of nearly 87K SF for the year, with a total vacancy of almost 23%, according to JLL. That is despite a state initiative relocating 700K SF of agency leases to the district in the fourth quarter alone. 

"Despite the State of Maryland’s move to the CBD, the downtown submarket will struggle to avoid chronic vacancy, as move-outs and relocations continue to occur at a faster rate," according to JLL's market report. "To remain competitive, older buildings in the CBD will require significant improvements, which may not be feasible at the current average asking rent."

While older office buildings face significant headwinds, Cushman & Wakefield's report suggests there will be opportunities for those properties to rebound over the next decade. But to capitalize on that potential, owners of older assets must invest in repositioning those buildings, the authors said. 

In areas like Baltimore city, where there is active leasing in the submarket dominated by amenity-filled modern properties, older assets can compete by making strategic capital investments in those properties, the researchers said. 

The report recommends owners consider enhancements like adding amenity space, modernizing common areas and upgrading elevators. But researchers warn owners can’t make improvements in a vacuum. Any upgrades must consider what sets a building apart from its competition.

The Cushman & Wakefield report, which examines how the office market will evolve over the next decade, also urges property owners to be aware of post-pandemic thematic shifts. 

Before 2020, according to the report, much of the emphasis in repositioning buildings focused on providing upgrades such as "spa-like" fitness centers, high-end lounges and state-of-the-art conference centers. 

While those features continue to be popular, there has been what the report calls a "thematic shift" in the upgrades at properties stemming from the pandemic. 

As a result, owners must consider changes like rooftop expansions, large state-of-the-art conference centers that shrink tenants' footprints, and spec or turnkey office suites.

McCurdy and Corbett acknowledged significant challenges to enacting those recommendations. Arguably the biggest obstacle for struggling properties is finding capital to invest in repositioning. 

"Obviously, from a funding perspective, that's a huge constraint, and I think our goal with the report … isn't to oversimplify any of it," Corbett said. "It's rather to say, 'OK, these are complex things, but the more proactive you can be now, the better,' because ... there's no magic way out of having a potentially competitive or functionally obsolete asset anymore."

While capital investments are essential, any investments must align with the property's location and infrastructure, McCurdy said. If owners fail to consider those factors, they may end up with repositioned buildings and new distressed loans, he said.  

"So those two things have to be aligned, and to the extent that they're not, there could be some fallout, obviously, in terms of owners that are not in the best position overall," McCurdy said.