By Todd C. Monahan, Wolf Commercial Real Estate, LLC/CORFAC International
The debt crisis facing many office building landlords may have a far greater impact than many are aware. Not only are many office properties overleveraged, but in some cases, so are their lenders. Many lenders are trying to reduce their office loan exposure and are reluctant to refinance their borrowers’ loans. Many small and regional banks have extensive real estate loan portfolios and now have stricter reserve requirements.
Most multi-tenant office building loans have three- to five-year terms and typically come with one- or two-year extensions. Many loans are interest only and were negotiated pre-pandemic, when interest rates were at historic lows in the 2.5-3.0% range. Office market dynamics were cresting, with rising rents, limited vacancy and strong demand indicators. In the corporate war for talent, companies were investing heavily in their office space with elaborate conference rooms, collaborative areas, open kitchens, gourmet coffee and sometimes even beer on tap.
Office landlords were also in an arms race to provide all the requisite amenities employers were seeking. In order to compete for tenants, landlords had to offer fitness centers, lounges, shared conference and meeting space, secure bike storage, rooftop patios and more. Pre-pandemic interest rates were at record lows and debt was cheap, so many landlords that refinanced after 2015 were taking out increasingly larger loans to add these amenities and offer large tenant improvement allowances to attract and retain tenants.
Pandemic Hangover
The pandemic and remote work trend changed everything. Now with loans coming due, office market dynamics are increasingly challenging. Office vacancy rates are over 20% in many major metros, not including shadow vacancies. It is estimated that one-third of all office leases in the U.S. will expire by 2026 and companies that want to retain office space are frequently downsizing. Given this, vacancy rates are likely to rise dramatically in the coming years.
An estimated $1.5 trillion in debt maturities are coming due by the end of 2025. With these market dynamics playing out, some landlords are threatening to “give the keys back to the bank” or already have. Over the past few months, the property giants RXR, Columbia Property Trust, Brookfield Asset Management, and others have collectively defaulted on billions in commercial property loans. Such defaults are partly an indication of real struggles and partly a game of chicken. Naturally the banks don’t want the properties, but are often reluctant to refinance.
Positive Signs
There are positive signs in certain situations. Workspace Property Trust obtained a two-year extension for a $1.3B CMBS loan associated with a portfolio of about 10M square feet of suburban office and industrial space, which represents roughly half of its holdings. The loan is tied to 146 properties in 14 markets nationwide, which includes a portfolio in Chesterbrook and Horsham, Pennsylvania, that WPT acquired from Liberty Property Trust.
In May, the loan was transferred to a special servicer and it was scheduled to mature this month without any extension options. An important part of the deal was that the existing investors made a significant amount of new investment into the refinancing equation. Some of those funds were used for a paydown and some were used to increase leasing reserves for growth and working capital.
In another instance in the Midwest, the special servicer for 601W, a major office property in downtown Chicago, recently approved a four-year extension of the property’s $536M senior loan ahead of its July maturity date.
Other office owners have essentially been paying to extend their loans. For instance, RFR Realty reached an extension in May with holders of the $783M mortgage for 300 Park Ave. in midtown Manhattan. The company agreed to pay down $15M of the principal, as well as to pay off a further $40M over the next two years to cover special servicing and other lender expenses.
Banks Remain Concerned
Rising interest rates have devalued many assets on banks’ balance sheets, especially government bonds, leaving them vulnerable to bank runs. In recent months, Silicon Valley Bank, First Republic and Signature all collapsed. Regional institutions like these account for nearly 70 percent of all commercial property bank loans. Pushing down the valuation of office buildings or taking possession of foreclosed properties would further weaken their balance sheets.
Municipal governments have even more to worry about. In many cities, office property taxes support a large percentage of city budgets. In New York City, such taxes generate approximately 40 percent of revenue. Many cities face a difficult choice. If they cut certain services, they could become less attractive and trigger a possible “urban doom loop” that pushes even more people away, hurts revenue, and perpetuates a cycle of decline. If they raise taxes, they could alienate wealthy residents, who are now more mobile than ever. Losing wealthy residents to low-tax states such as Florida and Texas is already taking a toll on New York and California. The income-tax base of both states has shrunk by tens of billions since the pandemic began.
Finally, turmoil in office markets threatens retirement systems and the portfolios of individual people. Public and private pension funds keep a majority of their assets in stocks, bonds and cash. However, office building debt and equity make up a percentage of their investments and have significant exposure. How all this plays out will be both painful and fascinating. Buckle up!
Todd C. Monahan is executive VP and managing director at Wolf Commercial Real Estate, LLC/CORFAC International.
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