Severe crash coming for US office properties, investors say

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NEW YORK – Office prices in the United States are due for a crash, and the commercial real estate market faces at least another nine months of declines, according to Bloomberg’s latest Markets Live (MLIV) Pulse survey.

About two-thirds of the 919 respondents surveyed by Bloomberg believe that the US office market will only rebound after a severe collapse. An even greater majority say that US commercial real estate prices will not hit bottom until the second half of 2024 or later.

That is bad news for the US$1.5 trillion (S$2 trillion) of commercial real estate debt that, according to Morgan Stanley, is due before the end of 2025. Refinancing it will not be easy, particularly the roughly 25 per cent of commercial property that is office buildings. A Green Street index of commercial property prices has already fallen 16 per cent from its peak in March 2022.

Commercial property values are getting hit hard by the Federal Reserve’s aggressive tightening campaign, which lifts a key cost of owning property – the expense of financing. But lenders looking to offload their exposure now are finding few palatable options, because there are not many buyers convinced that the market is close to a bottom.

“Nobody wants to sell at a huge loss,” said Barclays analyst Lea Overby. “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.”

Adding to the trouble is stress among regional banks, which held about 30 per cent of office building debt as at 2022, according to a March report from Goldman Sachs. Smaller banks saw their deposits shrink by nearly 2 per cent over the 12 months ended in August, according to the Fed, after Silicon Valley Bank and Signature Bank collapsed. That translates to less funding for the banks, giving them less capacity to lend.

Pain from higher interest rates can take years to filter through to owners of US commercial real estate, which Morgan Stanley values at US$11 trillion in total. Investors in office buildings, for example, often have long-term fixed-rate financing in place, and their tenants can be subject to long-term leases as well.

It will take until 2027 for leases that are in place today to roll over to lower revenue expectations, according to research by Moody’s Investors Service. If current trends hold, then revenues by then will be 10 per cent lower than today’s.

Even if there is a serious and prolonged downturn in US commercial real estate, including major loan losses from a cratering office sector, Ms Overby is not worried it will threaten overall market stability. The property sector is large, but the debt is spread across a wide enough array of investors to absorb losses, she said.

Besides high interest rates, offices are struggling with tenants cutting back or moving out, with the trend especially strong in the US, where employees are more reluctant to come back to work in their offices than in Europe or Asia. Some of the resistance to the return to offices could be attributed to commuting pains.

More than 40 per cent of MLIV Pulse respondents said they will be enticed to come to the office more often if they have better public transit options available. BLOOMBERG

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