Working from home means no commute, the comforts of home, the ability to sneak in house chores and more flexibility to manage non-work commitments. What’s not to like?
Well, employment-data analysis firm Live Data Technologies of the US tracked two million US white-collar workers and found that remote working limits career advancement and remote workers are more likely to be fired.
Besides teleworkers sacked or overlooked for promotion, two other groups are hurt by the popularity of working from home. These are the investors who own emptyish office blocks, and the banks and private equity firms that back them.
Office towers were always headed for trouble investment-wise after remote work became mainstream during the pandemic. The virus’s other blow to debt-reliant commercial property, which includes health, industrial, residential and retail sites, was economic. The emergency fiscal and monetary responses ignited inflation and led to higher interest rates.
Time was needed to determine the extent of the pandemic’s blow to commercial property. For the vulnerable office segment, it was unknown how promptly workers would return to offices and to what extent. Other delaying factors that encompass all segments were that tenants take years-long leases, that loans often contain extension clauses, and that property is only traded and valued intermittently.
By mid-2023 it was apparent that offices were struggling, so much so that McKinsey & Co forecast remote work could slash US$800 billion ($1.2 trillion) from office values in global hubs by 2030. The consultant estimated demand for office space will be 13 per cent lower in that year compared with 2019 due to remote working.
These might be optimistic forecasts. The Australian Bureau of Statistics reports 37 per cent of Australians worked regularly at home in August last year, compared with about 32 per cent in 2019 and a peak of 40 per cent in 2021. More telling is about 60 per cent of workers who used to clog offices work from home regularly compared with 22 per cent across other occupations.
US statistics are just as troubling. US property-security firm Kastle, which tracks the use of work passes in 41,000 businesses in 2,600 buildings in 138 cities in 47 US states, says US workplace capacity in September was only 50.4 per cent of pre-pandemic levels. Kastle’s ‘10 city average occupancy’ barometer, which tracks big metros including Chicago, Los Angeles, New York and Houston, in January only stood at 48.5 per cent of pre-pandemic levels.
Fewer staff in offices means businesses want smaller premises at reduced rent. Moody’s Analytics found a record 19.6 per cent of office space in major US cities was unleased in the fourth quarter. “Effective rents declined for a second straight quarter,” Moody’s says.
Lower demand pounding rents just as higher interest rates boost owner costs is battering valuations. In the US, office values have dived an estimated 20 per cent and many worry the decline could extend towards 50 per cent. Some US property trusts have defaulted. Europe is likewise struggling.
Similar woes are evident in Australia. Colliers Australia forecasts that Sydney prime office values, which have already tumbled 15 per cent, could dive as much as 27.5 per cent from their mid-2020 peak, The AFR reports.
Expect super funds and listed property trusts, prominent owners of commercial property in Australia, to slash valuations. Expect more property funds to limit withdrawals, to avoid selling property to meet redemptions.
Challenged debt renewals
The biggest danger for investors, though, is the US, because mid-sized banks are the most imperiled to any office crunch – the IMF estimates smaller and regional banks are almost five times as exposed as larger banks. The concern is the US office downturn could turn into a systemic financial crisis – have “adverse spillovers to the rest of the economy” in the IMF’s words – because so much debt needs renewing when US 10-year Treasury yields are about 4 per cent compared with less than 1 per cent in 2020.
The Mortgage Bankers Association of the US estimates that 20 per cent of US$4.7 trillion ($7.1 trillion) of outstanding debt on commercial property will mature this year – that’s US$929 billion ($1.4 trillion) worth of debt.
US-based Trepp, which provides analytics, data, and technology solutions, estimates banks and thrifts hold more than half of the loans maturing to 2028. “Lenders and borrowers will encounter challenges in rolling the volume of maturing debt,” Trepp warns.
Maturing loans refinanced at higher rates when rental income is dropping spells defaults. S&P Global Ratings says delinquencies on office-backed mortgages hit 5.8 per cent in December, the highest since 2017. During the month, delinquencies on commercial mortgage-backed securities rose to 4.1 per cent as offices overtook retail as the problem sector.
Fitch Ratings expects loan delinquencies on mortgage-backed securities to jump from 2.25 per cent last year to 4.5 per cent this year and then rise to 4.9 per cent in 2025. Offices are “highly vulnerable as the structural shift to hybrid working has reset valuations,” Fitch says. The company estimates the US office vacancy rate is 13.5 per cent, up from 9.5 per cent at the end of 2019.
Anecdotes abound of struggling office loans. Bloomberg News reports Blackstone is peddling the mortgage on a 26-floor Manhattan office tower at 50 per cent below face value. Fourth-quarter earnings releases shows that Bank of America wrote off US$100 million tied to eight office buildings, while Wells Fargo’s losses have reached US$377 million, media reports.
The shock announcements on February 1 (Australian time) of losses to US commercial property by New York Community Bancorp and Japan’s Aozora Bank – and the wider blow to stocks – highlighted the threat little-known banks pose to asset prices.
Many worry that commercial property is floundering when economic conditions are stable. Any recession could be devastating for the investment option. If that were to happen, the next global banking crisis might have erupted.
Now, many office towers are holding their worth and office values only form a minority of commercial property’s worth (just 16 per cent in the US). But enough office blocks are losing value and offices are property’s bellwether.
No solution looms to salve the global struggles of offices. Remote working might cost vastly more than its proponents imagine.
For more on the risks and opportunities in the commercial and residential property sectors join us at the Investment Magazine Real Estate Forum at the InterContinental Melbourne on February 27.
