Office Distress Still Low, But Lease Expirations, Maturing Loans Loom Large
The coronavirus pandemic has not yet caused major distress for office owners, but the billions of loans out on properties with leases in their final stretch show just how much is at risk in the country’s priciest office markets.
Borrowers of about $3.3B in commercial mortgage-backed securities debt across 125 loans and 245 properties have requested forbearances so far, according to a joint Trepp and Compstak report released this month.
Roughly $27.7B of the $145B CMBS office loans Trepp tracks are set to mature by 2022. What’s more, nearly 35% of the total loan pool, or $50B, has exposure to a major tenant with a lease that will expire by the end of 2022, when many experts predict the economy will still be healing.
Most of the forbearance is in major metropolitan hubs, per the report, where there are “greater financing needs” and where the lockdowns were most severe and working from home has been widespread. New York City, Philadelphia, Los Angeles, Bridgeport, Connecticut, and Virginia Beach saw the most requests for help, according to Trepp and Compstak.
In the Greater New York office market, $4.1B — or just over 8% of the $48.8B in loan balance — is backed by office buildings with expiring leases.
"I think those tenants will recommit to New York City the way that Amazon, Google and Facebook have,” B6 Real Estate Advisors CEO Paul Massey said in an interview, adding he remains optimistic that office properties will retain their value in the coming years.
If distress were to come, he said, it will likely be Class-B and B-minus buildings that bear the brunt.
“I’m generally optimistic about office as a whole, I think this is just a phase similar to 9/11," Massey said. "Companies went to New Jersey, but then two years later, they were clamoring to be back.”
Across the commercial real estate industry overall, there is growing acceptance that foreclosures are around the corner. There were 278 properties backing securitized mortgages in foreclosure last week, The Wall Street Journal reported. As the pandemic wears on, the forbearance periods will start ending.
“It’s coming,” NAI Global CEO Jay Olshonsky said of foreclosures to WSJ. “It’s just a question of how bad is it going to be.”
On the whole, office owners are largely meeting their obligations. Nationally, the office CMBS delinquency rate was 2.28% in the September remittance cycle, according to data provided by Trepp, compared to nearly 9% for all other property types.
Special servicing rates for office assets were under 3%, compared to over 10% for other types. The CMBS foreclosure rates for office in September were less than 1%, which remains unchanged from the start of the year. The office delinquency rates in September decreased both month-over-month and year-over-year.
Office landlords have so far been reporting strong collections on rent, though there is creeping anxiety over how many companies have kept their workers remote in places like New York City.
“There has been a concern in the industry that the longer the low physical occupancy of tenants continues, this really great collection level may change,” said Marx Realty CEO Craig Deitelzweig, whose company owns more than 4M SF of office, retail and residential space nationally. He said he hasn't yet seen a change in collections in Marx's office portfolio.
But landlords who are actively leasing buildings right now are facing challenges. The average level of free rent as a part of a total lease term is now higher than it was at any point during the Great Recession, according to Compstak.
Leases New York City, Los Angeles, San Francisco, Chicago, Boston and Washington, D.C., have an average of more than 5% free rent included as of the second quarter. That marks a 30% jump on the same time period of last year.
“The trend is very similar to the last recession of 2008 and 2009,” said Compstak Vice President Wayne Yu, an author of the report.
The figures are based on second-quarter data, but as the third quarter is finalized, Yu said it appears the trend is continuing. He is also noticing landlords are increasingly willing to delay start dates for office leases, which is on top of the free rent they are throwing in for deals.
“Landlords want to lock in the leases to secure a contract, so they are willing to give tenants more time to move into a space, which is outside the contract," Yu said. "The lease starts later, and the free rent period is also longer.”
Silver Eagle Advisory Group co-founder Wendy Silverstein, a former Vornado and WeWork executive, said retail and hotel assets are dealing with immediate pain, while the long term impact on office is going to take longer to play out. Her new firm is focused on loan workouts.
“The nature of office leases are they are longer-term and higher quality,” she said. “We haven’t seen a lot of [office] distress, it will be fact- and circumstance-specific, but clearly if you believe there will be some diminution of value and roll-down of rent per SF, which is market dependent, there is likely going to be more distress coming in the office market in the next couple of years.”