A growing number of office owners who are struggling to pay off debt are handing over their buildings to their lenders.

More properties are being surrendered through so-called deeds in lieu of foreclosure, which are voluntary, unlike regular foreclosures that involve an involuntary seizure. And the option is being mentioned frequently in financial filings.

Office buildings made up 43% of all deed-in-lieus in the second quarter, the most recent full quarter of CoStar data available. That compares to a 20% average for all of 2022.

The increase comes against a backdrop of property owners being hindered in their ability to refinance maturing loans as rising interest rates have boosted borrowing costs. Lenders have also tightened their standards. Other owners simply are not willing to keep pouring money into properties they see as poor performers.

Voluntary surrenders are making up a larger portion of all foreclosures than before. In the first half of 2020, at the onset of the pandemic, office property deed-in-lieus made up 21% of all foreclosures before falling to 6% in the first half of 2022. However, in the second half of last year, the percentage rose to 30%. It was up again in the first half of this year to 33%.

A recent deed-in-lieu highlights why some borrowers are allowing properties to go to lenders: It’s better to cut losses and put money into other investments.

As a case in point, Blackstone Group and Boston Properties turned over a jointly owned Washington, D.C., office building in a voluntary transfer in October. Named Metropolitan Square, the property is a 12-story, 656,546-square-foot building with 14,023 square feet of retail space. Blackstone owned an 80% share of the joint venture, with Boston Properties owning the remainder.

With little to suggest a trend reversal or an inflection point, office building performance is expected to get worse before it gets better, according to a CoStar analysis.

The Blackstone-Boston Properties joint venture turned over Metropolitan Square to Artemis Real Estate Partners, which was the mezzanine lender on the property. The recorded transfer amount was $305 million, the amount of the unpaid loan secured in a deed of trust in 2022, according to CoStar data.

“We effectively wrote this investment off last year and continue to actively manage our portfolio to deliver the best possible investment outcomes based on evolving market conditions,” a Blackstone spokesperson told CoStar News in an email.

Blackstone owned its stake through Blackstone Real Estate Partners VIII, a $16.6 billion fund that has otherwise posted a 15% internal rate of return, according to Blackstone’s third-quarter earnings report.

Washington, D.C.'s East End, where the property sits, is the sixth-largest office market in the nation as ranked by existing inventory. By some measures, though, few markets have a larger set of concerns. Office availability exceeds 25%, CoStar data shows. Tenant move-outs have exceeded move-ins in all but two quarters since the beginning of 2020. Asking rents are falling.

Blackstone has been selling office properties as it aims to invest in other sectors with stronger financial prospects propelled by growing demand, such as apartments, student housing, warehouses and data centers. Less than 2% of Blackstone’s portfolio is traditional U.S. office, the company has said.

The length of office shutdowns following the declaration of the pandemic in March 2020 varied from building to building, market to market and company to company. Nonetheless, it prompted many employers to examine how people work and from where they work.

That look at office space requirements is still ongoing. However, in-office attendance is down from before the pandemic and the amount of space being taken in new leases is lower as well, according to CoStar data.

“Now, borrowers are looking forward and just realizing that even if they can get a modification on their loan, it's just not a feasible asset class for them to really even stay in,” Amy Hatch, financial services litigation vice chair at the Polsinelli law firm, said in an interview with CoStar News.

“They don't want to throw more money at it, and they would prefer to just tell the lender, ‘Look, I'm just going to turn over the keys to you. I've done everything I was supposed to do, but I just want to walk away from this and be done with it,’” said Hatch, who has significant nationwide experience with commercial loans and routinely assists lenders with foreclosures, receiverships and other workout options, including forbearance agreements and loan sales.

In addition to deeds in lieu of foreclosure, another measure of distress is the office buildings tied to loans on the commercial mortgage-backed securities market where borrowers have indicated intentions to walk away.

CoStar data shows 21 buildings totaling 2.6 million square feet in this situation, and about 49% of the space is vacant. Over the past year, vacancy has risen by 169,000 square feet.

Alex Killick, managing director for loan servicing firm CWCapital, has noticed the trend of more voluntary surrenders, he told CoStar News in an interview.

“We're also seeing a difference in borrower behavior, whether it's a very hyper-rational institutional borrowers who say, ‘The metrics don't work, and I'm done. I'm not going to put money in,’” Killick said. “But there are longer-term holders that are borrowers who've had an asset in the family for multiple generations or it's their trophy asset.”

CMBS special servicers, which monitor debt and are responsible for determining how it can be paid back, have been describing deed-in-lieus in their reports to bondholders.

The trustees of publicly offered multiborrower CMBS deals file monthly reports with the Securities and Exchange Commission. In October filings, CoStar News found 15 instances of special servicers disclosing that borrowers no longer wanted to support the properties backing their loans in full or in part. Eleven of the 15 loans financed 21 office buildings with an outstanding balance of $290 million.

By comparison, the same search criteria done for filings seven months earlier in March found just seven instances. Office loans made up four of the seven.

Special servicers have a fiduciary obligation to trustees of the CMBS deal and the bondholders to report information accurately.

“I'm seeing where the borrowers are calling their lender on a Monday and saying, ‘Why don't you come over and get your receiver appointed on Friday because I'm out,’” Hatch said.

For lenders and special servicers, there are not a lot of feasible options if a borrower wants to turn over a property, according to Hatch. The borrower has decided they don’t want the property; neither lenders nor special servicers typically want them.

“The hard part right now for everybody is that because of interest rates, it costs so much more to refinance. It's just a huge hit,” she said. “We lived in a world the last five years where when anything started to go south, maybe you lost a tenant or maybe the property value softened a little bit, you still could just refinance because money was so cheap. It wasn't that big of a deal. And now, refinancing is just not an option because the cost of money is so much more. The value of your property would have to increase significantly for that to make sense, and values aren't increasing significantly, in fact, they're decreasing.”

CoStar News contacted the 11 owners of all the properties noted in the October bondholder reports. Only two responded.

One of the owners who commented, Forstone Capital, owns 350 and 360 Fairfield Ave. in Bridgeport, Connecticut, two office buildings totaling 136,638 square feet. The properties are subject to a $7.7 million CMBS loan.

Brett Wilderman, principal of Forstone, told CoStar News in an email that he disagreed with the characterization that his firm stopped supporting the properties. Wilderman, however, said he was subject to a confidentiality agreement and could not disclose more information.

According to the special servicer’s note in September, the loan transferred for imminent monetary default. “The borrower informed the lender they are no longer willing to contribute additional capital to the property and wish to transition the property to the lender,” loan servicer commentary stated. The special servicer is monitoring the situation for a possible foreclosure or receivership sale.

The other owning entity who commented is One Presidential Associates, an affiliate of Keystone Property Development + Investment that owns One Presidential in Bala Cynwyd, Pennsylvania. The 133,383-square-foot office building is subject to a CMBS loan with a $28.2 million balance, according to CoStar data.

“As of Jan. 1, 2022, the property was 40% occupied,” Stacey Dennis, director of marketing and communications for Keystone Property, said in an email to CoStar. “The borrower and sponsor cooperated with each of the special servicers during the course of 2022 to effectuate an orderly transition of title to the property to an affiliate of the noteholder via a deed-in-lieu transaction that closed on Dec. 29, 2022.”

After closing, the special servicer retained an affiliate of the sponsor to manage and lease the property. Under that arrangement, a new lease was subsequently signed with a tenant for 18,302 square feet.

The occupancy rate has improved to 69%, according to CoStar data.