Record Office Lease Expirations Pose New Threat to Landlords and Banks

Most office building owners were able to ride out the pandemic because corporate tenants were locked into long-term leases. They continued to pay their rent even when their employees stayed home. Now that more leases are expiring, a growing number of tenants are downsizing their offices as they need less space under hybrid strategies that combine office and remote work, brokers say.

Leases for 243 million square feet of office space in the United States are due to expire in 2022, the most office space on the market in a single year since real estate services firm JLL began tracking this data in 2015. Expiring leases account for approximately 11%. of all office space leased across the country.

The increase in office space hitting the market this year is a direct result of the pandemic. Many office tenants whose leases expired last year or in 2020 have negotiated extensions of just a year or two, rather than renewing at the usual 10-year or longer term, as these companies have tried to determine how much less space they might need in a hybrid approach. .

“I don’t think landlords have felt the pain yet,” said Jeffrey Peck, vice president of commercial real estate brokerage firm Savills. “Now they will start to feel the pain.”

Imminent lease expirations represent a 40% increase since 2018 and pose a new threat to office owners already frustrated by stubbornly slow return-to-office rates and a national vacancy rate of 12.2%. That rate is high for the pandemic period and up from 9.6% at the end of 2019, according to real estate data firm CoStar Group Inc.

He could go higher. Real estate analysis firm Green Street estimates that hybrid working will lead to a 15% drop in demand for office space. Since most construction expenses are fixed, even a small drop in rental income often results in a big drop in profits and an even bigger drop in a building’s value. An economic downturn could add further strain, as office leasing is highly dependent on the economy.

Distressed loans to office building owners are also on the rise. In February, 21.2% of office loans issued after the global financial crisis bundled into commercial mortgage-backed securities were either managed by special services or on watch lists, two closely watched categories that could lead to defaults, according to a Barclays report. This is the highest level since 2010.

Esther George, president of the Federal Reserve Bank of Kansas City, said last month that she was concerned about the risks of remote working and rising interest rates, which could hurt office owners and their lenders.

“Community banks in particular may have concentrations in this area,” she said at an event hosted by the Economic Club of New York. “We see the structural changes that are happening right now.”

Analysts will be keeping an eye on office lending as banks start reporting their first quarter results in the coming weeks. Financial institutions most exposed to the office market include Heritage Financial Corp. and Eagle Bancorp Inc., both of which have more than 13% of their loan portfolios backed by office buildings, according to a report released Monday by financial services firm Stephens Inc.

So far, most lenders have been unaffected by their office loans, but that could change if a drop in leasing causes property values ​​to plummet. “We are watching closely,” said Chris McGratty, head of banking research for KBW.

About $1.1 trillion in office-backed loans are outstanding, and about $320 billion of those loans mature this year and next, according to data firm Trepp Inc.

Not all news is bad. Big tech companies have expanded by 12.1 million square feet since the pandemic began, according to JLL. Lenders were also more cautious in the years before the pandemic than in the periods before the two previous recessions. While lending volumes have hit record highs, banks and other lenders have generally stayed away from very high debt levels that offer little protection when values ​​fall.

But the combination of rising interest rates, falling occupancy rates and mountains of maturing debt “could be a triple whammy” for property owners, said Matthew Anderson, chief executive. by Trepp.

Problem loans have already started to surface. Blackstone Inc. is expected to return a struggling midtown Manhattan office building with $308 million in debt to creditors, according to people familiar with the company’s thinking. The building’s loan was turned over to a special fixer after its main tenant, L Brands, decided not to renew its lease when it expired last month. The retailer takes up much less space in a new location, in part because it’s moving to a hybrid work strategy.

A Blackstone spokeswoman said the building posed “a unique set of challenges that are not representative of our portfolio.”

Most tenants aren’t expected to increase their rental business anytime soon. Real estate data firm VTS said an indicator of tenant demand – the number of tours by space companies – in February was about half its pre-pandemic level. Businesses increasingly prefer shorter-term contracts, which creates more uncertainty for owners. Material ConneXion, a materials consultancy, for example, moved into a coworking space run by Serendipity Labs in Manhattan last year after abandoning its much larger Park Avenue office.

New York law firm Herrick Feinstein LLP wants to reduce its office space by 30% to 40% when its lease expires in a few years, said Jonathan Adelsberg, co-chairman of the firm’s real estate department.

He said he wasn’t thrilled to give up his private conference table, but spending less on office space means the firm’s lawyers can make more money. “You can have a bigger office or a bigger house,” he said. “I mean, what would you prefer?”

This story was published from a news agency feed with no text edits

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