MASS EXPIRATION OF OFFICE LEASES THREATEN LANDLORDS

Leases are expiring this year on 243 million square feet of office—about 11 percent of the total office space in the U.S.—at a time when businesses are adopting remote work as normal.
The footage becoming available is the most since at least 2015, according to data service JLL, the year in which it began tracking the number, and represents a 40-percent increase in unleased space compared to 2018.
The leases are expiring at a time when the national office vacancy rate is 12.2 percent, almost 25 percent more than the 9.2 percent just before the COVID virus arrived, real estate data firm CoStar noted.
Several major employers already have reduced their real estate footprints or have announced plans to do so, as we reported in “Remote Work Becomes Tech Sector’s New Normal” (1 Dec 2020), “HSBC Endorses Remote Work Model, Slashes Travel Budget” (14 Sep 2021) and elsewhere.
During the COVID War, bigger office landlords were cushioned by long-term leases that required companies to pay rent even if their workers stayed home.
Now a huge number of those contracts are expiring, putting many building owners in a squeeze: cut rents to what the market will bear to fill space, even if it means operating at a loss, or let space stand empty while it racks up maintenance fees, utility bills, and property taxes.
“I don’t think [large] landlords have felt the pain yet,” Jeffrey Peck, vice-chair at real estate brokerage Savills, told The Wall Street Journal. “Now they’re going to start feeling the pain.”
Because many basic expenses of running a building are fixed—climate control, maintenance, property taxes—even a slight drop in occupancy can flip a landlord’s balance sheet from profit to loss.
The current shift to remote work will cut demand for office space nationwide by 15 percent, according to Greenstreet, a real estate analytics firm, and a recession—seen by many economists as increasingly likely—will shrink demand even more.
As we noted in “Remote Work: The New Bottom Line” (15 Mar 2022), Fitch Ratings has calculated if companies surrender 10 percent of their office space as remote and hybrid work models take hold, the value of office buildings could plummet as much as 40 percent.
Partly as a result, troubled mortgage loans on office buildings are increasing.
In February, 21.2 percent of the mortgages bundled into mortgage-backed securities were either on watch lists or assigned to special servicers, meaning the loans are falling into arrears, the WSJ said.
Private equity giant Blackstone is predicted to surrender to creditors a Manhattan office building staggering under a $308 million debt. 
The mortgage was given to a special servicer after L Brands, the building’s anchor tenant, shifted to hybrid work model and leased a smaller space in a different location.
The impact of stumbles such as Blackrock’s will begin to be felt in markets when banks report first-quarter earnings in the weeks ahead. 
Heritage Bancorp and Eagle Financial Corp. each have at least 13 percent of their mortgage loans in office buildings, according to the WSJ.
About $1.1 trillion in mortgage loans for office buildings are outstanding, with $320 billion of them coming due this year, data firm Trepp said.
TREND FORECAST: Owners of commercial real estate will face a reckoning as they slash rents to lure a shrinking base of tenants, forcing them to demand property tax concessions from cities that will struggle even more to maintain police, fire, and public works infrastructures.
Although more people are returning to city centers to live, as we reported in “USA: Can’t Afford to Buy a Home, Can’t Pay the Rent” (15 Mar 2022), that will not be enough to fully restore the commercial ecosystem of restaurants, shops, and entertainment venues that grew up to serve a full complement of daily commuters.
As a result, downtown commercial centers in traditional office hubs such as New York City and San Francisco will not return to their pre-COVID size or vitality. We have detailed this trend in articles such as “Retail Chains Abandon Manhattan” (18 Aug 2020) and “Manhattan’s Commercial Real Estate Crash” (21 Sep 2021).
Landlords and investors have been contemplating turning empty office spaces into condos and apartments. However, a similar move to convert derelict hotels into residences has been snarled in regulations, which we detailed in “Plan to Turn New York’s Vacant Hotels Into Housing Not Working” (5 Apr 2022).