BLOOMBERG CATCHES UP TO CELENTE, REPORTS COMMERCIAL REAL ESTATE CRASH
Echoing Gerald Celente’s July 2020 forecast, Bloomberg’s Markets Live Pulse survey reports that a majority of 919 respondents believe that the market value of U.S. office buildings is due to crash.
Property prices peaked in March 2022 and have declined 16 percent since then, according to data service Green Street.
About 600 survey participants believe the market will recover only after it collapses and more than two-thirds of respondents say that values will continue falling at least until the second half of next year.
Roughly $1.5 trillion in commercial real estate loans are coming due before 2026, according to Morgan Stanley. About 25 percent of those properties are office buildings.
Office landlords will have a hard time paying off or refinancing those loans, especially since new loans will carry interest rates more than double those of what they were in 2021.
Also, the shift to remote work has gutted office space. The occupancy rate in 10 major U.S. cities was 50.4 percent last week, according to security firm Kastle Systems, which monitors swipe card use. Occupancy has remained with a few points of that number for more than a year.
To keep current tenants and attract new ones to fill the empty spaces, landlords have been forced to cut rents for all but the newest buildings and offer goodies such as free months’ rent or free redecorating.
At the same time, inflation has driven buildings’ operating costs higher, leaving landlords with thinner and thinner margins or erasing them entirely.
Some major office building owners already have defaulted on their mortgages or handed the properties back to their lenders, as we detailed in “Top Private Equity Firm Defaults on Two Office Tower Loans” (21 Feb 2023) and “Office Tower Owner Defaults on $1.7 Billion in Mortgages” (28 Feb 2023).
Meanwhile, lenders have troubles of their own.
Depositors have transferred billions of dollars out of banks to high-yielding money market funds, which we reported in “Money Market Funds Continue to Rake In Record Cash” (30 May 2023) and “Money Market Funds Up $1 Trillion This Year” (19 Sep 2023), among other articles. While seeing deposits shrink, banks also are having to pay higher interest rates to keep the depositors they still have.
Banks also have been forced to set aside larger amounts of cash as cushions against a rising tide of bad loans. As a result, banks are making fewer loans and being more selective about who they lend to.
Small and regional banks hold more than half of U.S. commercial real estate debt. Refinancing increasingly risky loans in a sliding real estate market will not be a priority.
Similarly, investors are unlikely to buy properties now that values are on the way down—and, for now, owners are reluctant to sell.
“Nobody wants to sell at a huge loss,” Barclays analyst Lea Overby said in comments quoted by Yahoo Finance. “These are properties that don’t need to be sold for long periods of time, and that means holders are likely to delay a sale as long as they can.”
“The office sector is deeply distressed, which will take a long time to work out,” she added.
PUBLISHER’S NOTE: The office building bust is one of our most active Top Trends 2023, although we predicted the collapse of the office economy early in the COVID War and on through a series of detailed reports, including:
- “Commercial Real Estate in a Tailspin” (20 Oct 2020)
- “Deloitte Abandons More London Office Space” (26 Apr 2022)
- “GM Softens Back-to-the-Office Requirement After Worker Backlash” (4 Oct 2022)
- “New York City’s Workforce Sharply Shrinking” (24 Jan 2023)
- “Office Occupancy Half of What It Used to Be” (7 Feb 2023)
- “Study: One Billion Square Feet of U.S. Office Space Will Be Empty by 2030” (28 Feb 2023)
- “Remote Work Could Slash Global Value of Office Buildings by $800 Billion” (18 Jul 2023)
TREND FORECAST: A majority of Bloomberg’s survey respondents expect the market to recover. It may stabilize after next year, but it will never “recover” to pre-COVID levels.
Although employers are demanding that workers return to a five-day, 9-to-5 in-office routine, too many workers are pushing back and insisting on a hybrid or fully remote arrangement. As long as the labor market remains tight, those workers will prevail, especially those in high-demand sectors.
Because remote work is here to stay, a large percentage of existing office space has become permanently “surplus to requirements,” as the British say.
Older buildings in need of repairs or updating will be unable to pay their way as tenants shrink their space needs and-or migrant to newer buildings with more amenities, such as green energy systems, better air circulation, more natural light, and even fitness centers.
The forecast we made earlier remains on track: As we wrote in “As Forecast: Office Building Bust Begins to Bite” (20 Dec 2022), thousands of office buildings, especially older ones, across the U.S., are doomed.
Some may be converted to apartments, but only those accidentally suited to financially feasible conversion. Most are not suited, for reasons we explained in “Plan to Turn New York’s Vacant Hotels To Housing Not Working” (5 Apr 2022) and “Wall Street, Dead Street. Office Buildings Going Condo” (28 Jun 2022).
As we have noted before, some creative landlords will meet city dwellers’ need for experiences by opening their empty office space to yoga studios, music academies, coffee houses, adult education centers, and other service-oriented enterprises—if their buildings are not in need of serious repairs.
These landlords will find interested partners in city agencies that will need to provide waivers or changes to zoning ordinances, building codes, and other regulations to accommodate these new tenants.
However, landlords will be stuck holding many buildings unable to pay their way.
Eventually, these owners will default on their taxes or mortgages. Ultimately, cities will wind up owning portfolios of empty office buildings that no one can afford to keep up.
At that point, the real estate will be sold for cheap, relatively speaking, and buildings will be demolished to prepare the sites for new lives in a new economy.
TRENDPOST: Further illustrating the severity of the Office Building Bust which most of the business ignores because they don’t want to freak out “investors” who gamble the markets, Meta Platforms, Facebook’s parent company, has paid £149 million to property owner British Land to cancel its remaining lease on space at 1 Triton Square, a major development underway in downtown London.
The sum is equivalent to about seven years’ rent on the space. Meta signed a 25-year lease on the space in 2021 as the building was undergoing a major renovation but has never occupied it.
The owner will now be free to re-lease the space at a higher rate, although London’s office market faces the same pressures from inflation and hybrid work as those in other major cities.
“It’s a staggering amount of money,” Matthew Saperia, a Peel Hunt analyst, said to the Financial Times. “I can’t think of a tenant paying [so much] to give back space they don’t occupy.”
Meta is hoping to escape or sublet about a million square feet of office space across Europe, according to Colm Lauder, a real estate analyst at Goodby, told the FT.
COMMERCIAL PROPERTY INSURANCE RATES SKYROCKET
Thanks to inflation, the growing number of extreme weather events, and a disappearing reinsurance market, office building owners are seeing their property insurance premiums climb at a frightening clip.
For example, Three Pillars Capital Group paid $630,474 to insure one of its properties. In May, when the policy was due to expire, the insurance company quoted the new price for the same coverage as $1.8 million.
“I have never seen such a significant and rapid change in insurance capacity as well as spikes in pricing,” Alexandra Glickman, chief of the real estate practice at consulting firm Gallagher, told the Wall Street Journal.
Insurance costs have jumped an average of 7.6 percent a year since 2017, Moody’s Analytics reported. Depending on the property and its location, those increases have piled hundreds of thousands of dollars of extra costs onto office landlords.
Office property owners already are facing a daunting array of troubles, chief among them the shift to remote work. The transition has the national office vacancy rate close to 20 percent, according to the WSJ, forcing landlords to cut rents and offer goodies such as free months or free redecorating to draw new tenants and hold existing ones.
At the same time, office owners face inflating costs for maintenance and squabbles with cities as landlords push to lower their property values to cut their tax bills.
While many office landlords are due to refinance hefty loans on their buildings over the next few years, many others signed deals when interest rates were low.
Loans are repaid over many years. In contrast, insurance contracts are renewed annually. As a result, even property owners with low loan interest rates are still being hammered hard by soaring insurance premiums.
“That means virtually every property owner has been forced to either sign a new policy at a higher cost or skip insurance altogether,” the WSJ noted.
Typically, lenders want property owners to insure for the replacement cost of the entire building. Now many property owners are arguing that partial replacement cost should be good enough because in a disaster, the entire building is rarely destroyed. That would reduce policy premiums.
Banks are beginning to accept that argument, especially if the lower insurance cost might save the borrower from defaulting on a loan, the WSJ said.
Relentlessly climbing insurance costs are a key factor keeping investors away from office properties. The number of commercial property sales of $25 million or more has plunged 79 percent since 2021, according to data service CoStar Group.
“Deals that may have just fit” investors’ financial requirements in the past “are now off the table because the insurance costs are just too high,” managing partner Ian Bell of Olive Tree Holdings said to the WSJ.
TREND FORECAST: Again, the headline news continues to sell the line that inflation has eased, while essentially ignoring how it keeps rising to record levels in various sectors. Moreover, the higher costs of insurance, maintenance, utilities, taxes, etc. rise, the deeper the commercial real estate sector will sink:
- “SPOTLIGHT: REAL ESTATE’S TAILSPIN” (24 Jan 2023)
- “SPOTLIGHT: OFFICE BUILDING BUST” (25 Apr 2023)
- “TOP TREND 2023, OFFICE BUILDING BUST: PRICE OF HEDGING INTEREST RATES WALLOPS OFFICE LANDLORDS” (9 May 2023)
- “SPOTLIGHT, TOP TREND 2023: OFFICE BUILDING BUST” (6 Jun 2023)
- “SPOTLIGHT, TOP TREND 2023: OFFICE BUILDING BUST” (1 Aug 2023)