In this section we provide an overview, trends analysis and trend forecast of the Office Building Bust which we had forecast three years ago… and is just making the mainstream business news now:

• Banks’ Office Building Loans May Be Worth 77 Cents on the Dollar
• Office Leasing Slump Reaches High-End Buildings

BANKS’ OFFICE BUILDING LOANS MAY BE WORTH 77 CENTS ON THE DOLLAR

Last week, federal bank regulators sold Silicon Valley Bank’s assets with a book value of $72 billion but they only fetched $55.5 billion from buyer First Citizens Bank, roughly 77 cents on the dollar.

The news focused attention on the value of current commercial real estate loans, given the properties’ sinking value amid higher interest rates, falling occupancies, and a tighter lending environment.

The bank held only about $2.6 billion in commercial real estate loans.

Unlike stocks, real estate loans are not sold in markets open to public view. Calculating the value of a real estate loan can be as much art as science.

Still, “the Silicon Valley Bank trade created a baseline for the market,” CEO David Blatt at CapStack Partners, which buys commercial real estate loans from banks, told MarketWatch. “To me, [77 cents on the dollar] is the top end, not the bottom.”

“Everybody has been operating under this hold-to-maturity veneer,” he added. “There’s just no way these things get resolved at [face value].” Thanks to the Silicon Valley sale, “the write-down is implied.”

The commercial property industry is awaiting the sale of $60 billion in assets from the failed Signature Bank to see if the same 23-percent discount pertains.

The Silicon Valley mess has made it harder for banks to “sweep it all under the rug” when it comes to unrealized losses in commercial real estate loans, Jack Mullen, founder of real estate advisory firm Summer Street Partners, said to MarketWatch.

Those unrealized losses are “coming right to the front of the line on the regulatory side,” he added. “People are super-mindful of it.”

In Manhattan, the value of older office towers could plunge 70 percent, according to Stijn van Nieuwerburgh, a New York University finance professor and real estate specialist.

“Forty percent of that [loss of value] is coming from [higher] interest rates alone,” he told a 30 March conference on turning old office buildings into apartments.

In that case, the value of loans on those properties would be likely to fall much further than 23 percent.

TRENDPOST: Silicon Valley Bank was not the only institution sitting on vast unrealized losses in low-yielding government securities. U.S. banks together are holding an estimated $620 billion worth of losses in those notes and bonds, analysts have said. (See “Lax Oversight Allowed Banks to Fail, Experts Say” 28 Mar 2023.)

Banks and regulators have yet to address the billions’ worth of unrealized losses hiding in loans to office buildings whose value has been sliding for three years.

Those losses will enter the headlines when these loans come due in large numbers over the next four years. When that happens, the real estate industry will experience another 2007-style crash that will shake the foundations of both the banking and real estate industries.

Municipal governments will join landlords at the center of the storm.

Falling property values mean lower property taxes, which account for half or more of cities’ operating budgets. 

And while the mainstream media and politicians keep selling the line that the offices will be converted to affordable housing, the reality, according to the data, is that offices constructed over the last 50 years are non-convertible to housing. 

OFFICE LEASING SLUMP REACHES HIGH-END BUILDINGS

The work-from-anywhere revolution left older office buildings with vast empty spaces and landlords scrambling for tenants as companies migrated to glitzy newer towers boasting amenities such as workout rooms, spas, natural light, and environmentally friendly energy systems.

Now the office bust is finding its way to even these so-called Class A properties that are the “most prestigious buildings competing for premier office users with rents above average for the area,” according to VTS, which makes management software for commercial property owners.   

For the first time since 2021, the volume of Class A office space being leased declined in last year’s fourth quarter, Moody’s Analytics reported, and some prominent property owners have defaulted on their mortgages, which we reported in “Office Tower Owner Defaults on $1.7 Billion in Mortgages.”

“Any property owner that says, ‘oh, we’re fine’ is fooling themselves,” Thomas LaSalvia, Moody’s research director, told The Wall Street Journal.

Almost 19 percent of Class A office space in Manhattan was open for lease in the last quarter of 2022, the brokerage Savills said, compared to 11.5 percent early in 2019.

Surprisingly, slightly more Class A square footage was empty than office space in classes B and C buildings, Savills noted.

Overall office vacancies totaled more than 16 percent, with leasing at its most sluggish since 2021’s second quarter, brokerage Jones Lang LaSalle said.

In this year’s first three months, another 1.5 million square feet of space flooded the island’s commercial real estate market when a new Fifth Ave. tower was completed.

At the same time, the volume of space open for subleasing continues to grow.

The lack of demand throughout the U.S. has cut the market value of office buildings by 25 percent, according to estimates by Green Street, a real estate services and research firm.

The loss of value is only one of the ills office landlords are coping with.

Tenants are migrating to home offices or cheaper space, squeezing landlords’ margins and cash flow. Tech companies have dumped hundreds of thousands of workers and are shrinking their office spaces accordingly.

At the same time, higher interest rates are making it more costly—too costly, in some cases—to upgrade buildings to be more attractive to companies that still need a central office.

Those higher rates also make mortgages more expensive. As a result, fewer investors are interested in owning office blocks, especially when alternatives such as high-grade corporate bonds bring respectable returns with far less risk and trouble.

“A meaningful amount of the existing office inventory may have a higher and better use as an alternative product,” Douglas Linde, president of Boston Properties, said in a Wall Street Journal interview. “It’s not relevant to users searching for space today.”

About $2.6 trillion in loans against office buildings will mature from now through 2027 and defaults are expected to increase as loans made when interest rates were still at rock bottom expire and must be renegotiated, research service Trepp predicted.

Michael Silver, chair of Vestian Global Workplace Services, advises law firms on their office space needs. Many expect to cut their space by almost a third when their current leases expire, he told the WSJ.

“That’s going to contribute to overall vacancy and it doesn’t matter whether you’re in an A building or a B building,” he added. 

TREND FORECAST: When the COVID War began, we were first to forecast the crash in value of commercial office properties. Our forecast has come to pass, as we have documented in a series of articles, 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)
• “Business Office Bust Begins to Bite” (20 Dec 2022)
• “New York City’s Workforce Sharply Shrinking” (24 Jan 2023)
• “Office Occupancy Half of What It Used to Be” (7 Feb 2023)

However, we could not have predicted then that a banking crisis would make the predicament of office building owners much worse.

While banks may recover from their industry’s current troubles, office real estate will not. Last month’s banking crisis may ease but it has only sharpened focus on the sliding value of office real estate.

That additional focus is likely to push property values down further and at a faster pace than previously.