Is fin(anci)al reckoning looming for commercial property?
It is starting to feel as if we have gained the upper hand on the pandemic, and companies are increasingly calling their workers back to the office. For example, Jamie Dimon, the CEO of JP Morgan, called his employees back to work by July. On the other hand, several big tech companies, including Salesforce, Facebook and Amazon, are gravitating toward a “hybrid” model, in which there will be a combination of both working from the office and from home. Taken together, it is unclear what these developments imply for the future of commercial real estate in general, and office specifically.
As could be expected, it seems like corporations are rethinking their property needs, with many downsizing or delaying new leases. Globally, more than 103 million square feet of office space has already been vacated since the start of the pandemic. This amounts to 18% more vacant floor space than during the financial crisis of 2007-09! In the United States, office vacancy rates have increased to 18% (see figure 1).
However, this gloom does not seem to be reflected, yet, in real estate price and credit measures. First, collection rates among the world’s biggest office landlords stands at an average of 98%, according to a study by the Economist. Second, delinquency rates on commercial-mortgage backed securities collaterized by offices seem to be flat, at around 2%. Finally, office sales prices in major cities seem to be unperturbed by the pandemic (see figure 2). Yet, it should be noted that several factors could be obscuring these measures. For example, stimulus packages have likely postponed increases in delinquencies and distressed sales.
One way to get around the noise is to look at more forward-looking measures of valuations. One such measure is Green Street’s price index, based on appraisals, which is 9% below its pre-pandemic peak in America. Furthermore, share prices of office REITs are still 13% below their level in early 2020 (see chart 3). These measures show a different story compared to the observations above.
The fate of commercial property remains unclear. If it depends on vacancy rates, then the future of commercial property might be gloomy, and much more than pricing and delinquency rates may reveal. By the end of year, we should have a clearer picture...