There's a growing cohort of office landlords across the country pointing to signs of a strengthened rebound. Some, however, are struggling against a tide of lease terminations as they look to backfill space left behind by tenants prioritizing space elsewhere.
Franklin Street Properties, an office real estate investment trust based in Massachusetts, is contending with a rising vacancy rate and dwindling leasing activity across its nearly 5.5 million-square-foot portfolio, underscoring the widening divide between owners of high-end properties versus those on the lower end of the market's spectrum.
What's more, CEO George Carter told analysts on the company's earnings call Wednesday that a "significant lack of liquidity" is hampering the REIT's plan to fine-tune its portfolio, as it tries to shore up its cash reserves by getting rid of the properties that have been more challenging to pitch to prospective tenants.
"This liquidity shortage for traditional office property investment and executing a legitimate transactionable bid regardless of price is harder than ever," Carter said, adding the company's leasing markets are not as active as they were prior to the pandemic, despite employee office attendance making "slow, but positive progress."
Occupancy across the landlord's portfolio — concentrated in markets such as Denver, Houston, Dallas, Minneapolis, Atlanta, and elsewhere across the Midwest and Sun Belt regions — remained on a downward slope through the second quarter ended June 30, falling to about 72% from the 74% it reported at year-end 2023.
Franklin Street Properties attributed the occupancy drop to lease terminations and the decision to sell its last property in the greater Richmond, Virginia, area. The company landed $31 million for the three-property portfolio deal that included the buildings at 5600, 5620 and 5640 Cox Road in Glen Allen, Virginia, and collectively total just shy of 312,500 square feet of office space, according to CoStar data.
The company signed about 75,000 square feet of leases through the recent three-month period of the year, not enough to fill the amount of space tenants have offloaded within the same amount of time. The landlord is also staring down more than 1.2 million square feet of looming lease expirations through the end of 2026, about 15% of which will land before the end of this year.
The company reported a net loss of more than $21 million for the second quarter, significantly more than the roughly $8.4 million loss it reported for the same period last year.
Mind The Gap
Franklin's challenges in filling space across its portfolio is another sign that, despite growing optimism about its recovery, the national office market faces hurdles in adapting to a post-pandemic landscape, especially when it comes to the widening divide between high-end properties and older ones in less desirable locations.
The average vacancy rate among top-tier properties was less than 15% by the end of the first quarter this year, according to CoStar data, below the more than 19% reported among non-prime buildings, or those that have fewer amenities or are located in less desirable areas. The gap in vacancy rates between the two quality types jumped from less than 2 percentage points in mid-2018 to about 4.5 percentage points by the end of March.
Tenants collectively signed on for 50 million square feet of high-quality office space in the United States between the first quarter of 2020 and the end of the first quarter of this year, according to a report from property brokerage CBRE. By comparison, non-prime buildings lost a total of about 170 million square feet of deals, as many companies opted to ditch their space and relocate to nicer properties.
That gap could continue to widen as some older buildings struggle to retain their tenant rosters as an increasing number of companies look to upgrade to more desirable buildings as a tool for providing a better workplace experience.
Despite the challenges, Franklin Street Properties executives point to signs of increased liquidity and demand for office space on the horizon. Executive Vice President John Donahue said on the call that Denver, in particular, "has shown signs of street level activity not seen since the pandemic."
"The urban markets and [Franklin Street Properties'] portfolio appear to be incrementally healthier and more vibrant this summer compared to the past few years," he said. "Some markets have been very slow to come back, and we are very encouraged about what we've seen here over the last three to six months."