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Office Landlord Defaults on the Rise as Employees Continue to Work From Home

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Office landlord defaults are on the rise throughout the United States as employees continue to work from home.

The list of major commercial real estate landlords defaulting on their loans is beginning to climb, as more developers begin to realize that American workers are increasingly preferring to work remotely or via a hybrid model, which may leave a permanent impact on the U.S. office market.

At least $92 billion of office mortgages are maturing this year, putting landlords under increasing pressure, while two of America’s largest commercial property owners are on the verge of non-payment on their debts, reported Bloomberg.

In addition to the $92 billion in debt owed to nonbank lenders coming in 2023, another $58 billion will mature in 2024, according to the Mortgage Bankers Association.

As the Federal Reserve continues to raise its benchmark rate, over 17 percent of office space in the United States remains vacant, with an additional 4.3 percent available for sublease, according to commercial real estate services and investment firm CBRE.

Many of these mortgages have floating-rate debts, which hit many landlords hard after monthly mortgage payments soared when the Fed started increasing interest rates last year.

Matt Rocco, chairman of the Mortgage Bankers Association, told Bloomberg that office values in the United States were down 20 percent from January through March 2020..

However, he predicts that the decline in office prices will eventually outpace the drop for commercial real estate prices by a large margin.

Defaults on Office Space in Q1 2023

Many office properties have struggled since the pandemic with the rise of remote and hybrid work models and recent layoffs.

CBRE said that economic uncertainty, “coupled with occupier downsizings due to hybrid work, caused leasing activity to drop by 23 percent quarter-over-quarter and by 36 percent year-over-year to 39 million sq. ft. in Q4, the lowest level since Q1 2021.”

Last week, Pacific Investment Management announced that it had defaulted on $1.7 billion of mortgage notes on seven buildings, which sent shockwaves through the commercial real estate market.

The seven buildings were located in San Francisco, New York, Boston and Jersey City, and were owned by Columbia Property Trust, which was acquired by Pimco in 2021 for $3.9 billion.

Meanwhile, Bloomberg reported that Brookfield Asset Management recently defaulted on over $750 million in debt for two 52-story towers in Los Angeles, according to a February SEC filing.

The real estate firm RXR, which owns 91 commercial properties with more than 30 million square feet, is currently negotiating with its creditors to restructure debt on a 34-story property at 61 Broadway in New York’s Financial District, reported The Wall Street Journal.

Scott Rechler, CEO of RXR, told the Journal that the rise in the office vacancy rate “gives tenants the ability to push pricing. So the market suffers through the transition.”

Another investment venture under going distress is between Related Companies and BentallGreenOak, which are in similar debt-restructuring talks over a $150 million warehouse to office conversion project in Long Island City, New York.

The two firms could not find enough tenants as expected, reported The Wall Street Journal.

Office Vacancy Rates a Driving Factor

The decline of the American office building sector has worsened, since the pandemic sent millions of workers home and the low return to office rate has hurt city property tax revenues, as tenancy levels plummeted.

The spike in interest rates since last year has exasperated the crisis, when it increased the cost of buying and refinancing properties, along with lowering property values.

So far, only 40 to 50 percent of American office workers have returned to their desks since the pandemic.

Most landlords were able to stay on top of their mortgages payments until recently, said The Wall Street Journal, since office leases normally run for 10 years or more, as most lenders have been willing to extend expiring leases.

However, as more and more landlords face distress, both owners and lenders are realizing that a return to normalcy at the office is failing to materialize, while the recent layoffs in the tech industry have not improved the situation.

At the moment, the delinquency rate for loans backing commercial-mortgage-backed securities still remains low, but is growing, Trepp, a data firm, told The Wall Street Journal.

Default rates in February rose by a quarter of a percentage point to 1.83 percent, its largest increase since December 2021, the firm said.

Trepp reported that $1.2 trillion of debt was related to office buildings at the end of the third quarter of 2022.

It reported that loans backed by office buildings throughout the country are increasingly being sent to special servicers, or were involved with bond issues that have been downgraded by credit rating firms in recent weeks.

Lenders are increasingly avoiding financing new mortgages backed by office spaces unless they are fully leased for long periods of time by established tenants with strong credit.

Lenders, Landlords Likely to Negotiate on Leases

However, in general, commercial office landlords are still remaining calm, since the best office space in key U.S. metropolitan locations are still attracting tenants.

The Journal reported that property owners hope that an economic downturn would encourage companies to order their employees back into the office, as the labor market softens, although few expect that office occupancy rates will return to pre-pandemic levels.

Although financially draining, most commercial real estate owners are unlikely to be devastated by losing buildings to creditors after a default, as investors normally structure their individual properties as separate financial entities.

Creditors who do choose to foreclose on the building would have little ability to collect against the rest of the company, if a landlord defaults on their loan.

Most lenders have major financial disincentives to foreclose on properties, as such procedures would normally write down the value of their loans and require them to pay transfer taxes.

Commercial office restructurings often end up allowing owners to put up new equity in exchange for reductions in their loan sizes or offer new terms for their lenders.

Other landlords negotiate to agree to a new business plan with their financial backers, such as converting office building space into residential apartments.

The increasing amount of commercial foreclosures is likely to put pressure on the greater U.S. economy, as the negative impact on the office sector is expected to take years to resolve.

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