In the era of remote work, the global commercial real estate industry is facing a daunting challenge, often referred to as an “apocalypse.” The combination of rising interest rates and debt maturities has led to a situation where properties sit empty and owners, unable to meet loan obligations, hand their keys back to lenders. Harold Bordwin, a managing director at Keen-Summit Capital Partners, explains that even if a building has the same tenants and income as it did a few years ago, if its debt is due, it becomes a significant problem. The wave of inflation that reached a 40-year high last year exacerbates the situation, causing owners to worry. Moreover, as the Federal Reserve continues to tighten policy to achieve its 2% inflation target, the returns on risk-free government bonds rise, compelling commercial real estate investors to demand greater yield to justify holding onto physical assets.
The consequences of this crisis are evident in the growing number of vacant spaces. Recently, the owners of San Francisco’s largest shopping centers abandoned their properties after 20 years due to declining sales, occupancy, and foot traffic. Similarly, commercial real estate owners in major cities like New York, San Francisco, London, and Hong Kong are surrendering their properties to lenders when their values fall below the secured debt amounts. US offices are also grappling with high vacancy rates, leading landlords to hand over keys to lenders.
A study conducted by economists from NYU Stern Business School, Columbia Business School, and the National Bureau of Economic Research revealed that vacancy rates in many American cities are at their highest level in 30 years. In Q1 of 2023, New York City had a staggering vacancy rate of 22.2%. The study predicts an even deeper plunge later this year as prices continue to decline. This decrease in property values results in lower tax revenue for cities. To compensate for the shortfall, cities may resort to raising taxes and fees, making living in these cities less desirable and further reducing revenue. Big Tech hub San Francisco is already experiencing the migration of companies like Salesforce, Tesla, and Oracle, as they seek alternative locations for their office spaces. The adverse effects on the city, where office workers accounted for a significant portion of the GDP, have been devastating.
Bordwin explains that lenders will face a difficult choice between “pushing mark to market” or “extending and pretending.” These tactics were previously employed during past financial crises, such as the savings and loan crisis of the ’80s and ’90s and the 2008 financial crisis. “Pushing mark to market” refers to selling distressed debt at low prices, while “extending and pretending” involves borrowers taking loans to avoid addressing the actual worth of collateral. However, Bordin notes the significant issue of obsolete space caused by the pandemic’s shift to remote and hybrid work models. There is no clear solution to this problem, and some buildings may eventually be demolished if they cannot be converted into residential or lab spaces.
The vacancy issue is not limited to the United States. In Hong Kong, where commercial real estate is incredibly expensive, a record-breaking 13 million square feet of office space remained empty in June, with 15% of the most valuable space vacant. Billionaire Li Ka-shing’s Cheung Kong Center, a 63-story tower, currently has a 25% vacancy rate. London is also experiencing lenders taking possession of two “trophy” office buildings.
In conclusion, the commercial real estate industry is grappling with a dire situation as remote work and economic factors combine, resulting in vacant properties, difficulty meeting debt obligations, and uncertainty about the future of these spaces.
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