Occupancy issues: A Starbucks location inside an office tower at 201 Spear Street in the financial district of San Francisco. Office use in the US hasn’t recovered from the Covid-19 pandemic as people persist in working from home. — Bloomberg
THE sense of impending doom in commercial property is almost inescapable in the United States and Europe, but evidence of actual disaster is scant.
Real estate experts and investors who specialise in distressed assets think it’s only a matter of time before landlords and lenders must face reality and yet finance officials like US Treasury secretary Janet Yellen say problems are manageable.
The truth is that the losses to come over the next few years will likely be as varied and specific as the experiences of different banks so far seem to be. There will be some stories of real pain like the losses for Blackstone Inc and its lenders on 1740 Broadway, New York.
But other owners will be filling units and raising rents on offices a little more than a stone’s throw away. In offices especially, the troubles look hyperlocal and dependent on the state of individual buildings rather than the kind of systemic crisis that comes with a deep and coordinated recession.
The prophecies of doom are very familiar: Office use hasn’t recovered from the Covid-19 pandemic as people persist in working from home, which also means some retail is suffering in sympathy; meanwhile, higher interest rates hurt building values and make refinancing terms costly for owners, and particularly painful where rent rises are difficult to achieve.
But that blanket characterisation hides a lot of variation. Occupancy rates in the Asia-Pacific region and Europe have recovered much more than in the United States broadly.Price declines in recently overbid markets, such as San Francisco, far outstrip those in other major US cities and European centres like Amsterdam or Paris, according to data from MSCI Real Assets. But even within cities, discrepancies between sub-districts are proving stubborn more than two years since lockdowns ended.
In Boston, for instance, some offices in the leafy and mixed Back Bay area are seeing rising rents for lease renewals, while in the financial district, space remains hard to fill and vacancy rates of nearly 20% are the highest of the three main central locations, according to CBRE Research.
Exposures also vary enormously across banks in the United States and Europe.
Take Deutsche Bank AG, which lifted provisions by nearly five times against commercial property lending sharply in its recent fourth-quarter results compared with the same period a year ago.
That sounds shocking, but the €123mil (US$132mil) it put aside amounted to less than 10% of net income in the quarter.
The German bank is relatively well-known for its real estate lending, and yet total commercial property loans on its book are less than 8% of all loans, below the average of nearly 9% for listed UK and European banks with more than €50bil in total lending, based on data from the banks and the European Banking Authority’s (EBA) transparency exercise.
Less than one-fifth of its €38bil in commercial property loans are to US offices. By contrast, Denmark’s Jyske Bank A/S has about one-third of its lending against commercial real estate, according to the EBA data. Nordic banks have more commercial property than other listed European banks, the EBA figures show, but they also have low loan-to-value ratios of around 40% on average, according to UBS Group AG analysts. Smaller listed European banks (with total loans between €10bil and €50bil) have higher average property exposures at more than 13%, EBA data show.
Unlisted cooperative banks, German Landesbanks and other private or government-owned lenders have average exposures of more than 20% – although that drops to 14% if we exclude two specialist real estate lenders Deutsche Pfandbriefbank AG and Aareal Bank AG.
Big international banks and property specialists have more US debt on their books than other Europeans. They mainly lend to offices in central downtown districts of major metropolitan centres, according to data from MSCI Real Assets.
That is a defensive characteristic, according to banks like Deutsche Bank, but their ultimate loss experience will be specific to the sub-districts and individual buildings they are in, as the Blackstone and Boston examples demonstrate.
American bank exposure to US property is dominated be smaller regional banks, which have more than doubled their collective lending to almost US$2 trillion over the past decade, while the 25 biggest banks have less than US$1 trillion.
Part of that growth has been in the six biggest US cities, where regionals have about one-quarter of the office market.
But they have bigger shares in secondary markets like Atlanta, Baltimore or Salt Lake City, and a majority share of 62% in tertiary markets, according to MSCI Real Assets.
They also have a greater share of suburban offices than central districts.
The worry for investors is whether regional US banks are putting enough money aside to cover potential losses. Lenders with less than US$100bil in total assets enjoy lighter regulation and supervision.
They tend to have lower provisions for bad debts than larger banks and those with the highest proportion of commercial property in their loan books have the lowest provisioning rates, according to analysts at Morgan Stanley.
But again, where exactly they are lending will matter. Some secondary cities are fine: For example, Austin, Dallas and Miami are attracting waves of finance firms fleeing higher taxes and property costs on the east and west coasts.
Others like Cincinnati or Detroit continue to see vacancy rates north of 20% and rising, according to Newmark Research.
The threat is of a hollowing out in cities with longer commutes and less attractive centres where stubbornly low office use leads to a spiral of other businesses closing and downtowns where no one wants to go.
Meantime, somewhere like San Francisco could see a strong rebound if developments in artificial intelligence bring a boom in related investment and startups.
For investors in banks, the key to the next couple of years will be getting as much detail as possible down to every building that each lender has. It’s going to be all about the nitty-gritty. — Bloomberg
Paul J. Davies writes for Bloomberg. The views expressed here are the writer’s own.
