Sunday 4 December 2022

Office landlords 'under pressure amid slowing economies'

LONDON, September 19, 2022

A new equilibrium has yet to emerge for global office real estate given the adoption of hybrid work model. Landlords are contending with higher vacancy rates, lower rent, and lower values over the next few years. Growing recession risk adds to the downside risk, according to S&P Global Ratings.
Overall, office space usage could settle at 15 to 20% below pre-pandemic levels over the longer term, it stated. 
S&P Global Ratings expects negative rating bias to increase for rated office REITs, and the credit implications to unfold over next two years given the long-term nature of leases and the diversity of tenants and assets.
While delinquencies of commercial mortgage-backed securities (CMBS) backed by office loans remain low, we believe the class B subsector will face ongoing challenges in the hybrid work environment and we will be examining the potential rating impact on conduit and single borrower CMBS deals, stated the global ratings agency in its review.
US banking sector exposure to loans, collateralized by nonresidential commercial properties, including offices, seems more manageable for larger banks. However for regional and community banks, it might be less manageable, it added.
S&P Global Ratings warned that local governments' revenue bases are at risk through lower property-related taxes and fees, particularly if assessed values for office assets go down.
According to CBRE, office vacancy in the US reached 16.9% as of June 30, 2022, the highest it has been since the Great Financial Crisis and one of the highest globally. (For comparison, office vacancy in Tokyo deteriorated to about 6% compared to about 2% pre-pandemic.) 
A resurgence of Covid cases, along with commuting and safety concerns, have delayed the return to office, and employees are settling into rituals of remote work. 
Despite increased vaccination rates and a lower death rate from Covid, office utilization remains low globally; it has been somewhat stronger in Tokyo, where office utilization is about 60% of pre-pandemic levels, compared to the US, where office utilization was only about 44% for a 10-city average as of July 2022, according to Kastle systems, which tracks keycard access to buildings, stated the report.
While S&P Global Ratings expects an uptick in office utilization after Labor Day in the US, overall office occupancy levels will likely remain well below pre-pandemic levels for the next few years, particularly given secular headwinds and slowing economic growth. 
"We expect office landlords to face several years of slow growth, with weaker prospects for leasing and fewer new development projects. While the operating performance for office REITs has been relatively resilient due to the
long-term nature of their leases and a stable tenant base, pressure will mount as leases expire," said the ratings agency in its review.
Tenants are reconfiguring the workspace to adapt to the hybrid work model, leading to an overall reduction in footprint in many cases. As a result, landlords will likely need to keep rent concessions high to attract tenants, pressuring profit margins and cash flow. 
"While leasing activity has recovered materially from 2020 levels, leasing volume remains 15%-20% below pre-pandemic levels in the US, and we expect a portion of the upcoming lease maturities to be at risk as tenant demand remains soft" it stated. 
"Still, we think the impact of remote working will be gradual given the prohibitive costs to end a lease prematurely. Rather, we would expect tenants to negotiate with landlords or consider moving to higher quality properties with better amenities," it added.-TradeArabia News Service


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