The linked article talks about the 50% office vacancy rate in Manhattan and why office to apartment conversion will be no panacea.
This is just a preview of what can become a major headache for REITs, banks, insurance companies, small businesses, states, and municipalities - not to mention the US Treasury as prospective tax receipts are affected.
An office real estate guru talking head on CNBC pointed out earlier that it costs $300 per square foot for an owner to renovate old, vacant Class-B office space in New York City, just to achieve an effective net income of only about $14 per square foot at current rent rates. He also mentioned that only about 10% of old office buildings can be converted into apartments or residential condominiums in New York, Chicago, San Francisco, or Los Angeles.
It appears that post-COVID, the only Class-A office tenants whose employees are willing to come into the office 4 days a week are large financial companies and law firms. Other office tenants are able to negotiate new lease rates on Class-B space that, in the aggregate, aren’t sufficient to justify the owners’ heating, air conditioning, and maintaining the building along with the property taxes and insurance. Old office building owners, including REITS, insurance companies, family offices, and other real estate investors who have outstanding debt obligations are increasingly likely to just surrender the property to the mortgage holder in the future.
In just a few years, we all may find out that large portfolio of negative-yielding commercial real estate is like an albatross around the neck of the owners and lenders (this is sometimes referred to as “Jingle Mail,” when the owner simply gives up hope and mails the keys to the bank).
Cities that rely upon the fat tax checks they have been receiving will find their cash-cows drying up, as will state revenue coffers previously filled by property taxes.
Insurance companies with large commercial real estate portfolios can find themselves holding the bag, as well.
There are a lot easier and less cash-or-labor-intensive ways to earn income than owning massive depreciating and disintegrating empty buildings.
BusinessWeek has the same story in this week’s issue (no link) titled “Defaults Are Coming to a Downtown Near You”. Citing similar occupancy stats, it notes that big landlords are just walking away from leases. While some of that is strategic positioning to renegotiate space, much of it is cash-strapped companies who were able to ride along on cheap money, but with interest rates rising have an incentive to get out sooner.
The Work From Home phenomenon hit with unusual speed thanks to the pandemic, and what was once seen as a stable, long term asset has suddenly become a risky, volatile one.
Shorts are betting that debt tied to offices will go into default; hedge funds are either 1) licking their lips waiting for bargains, or 2) crying because they’re on the wrong side of the deal now.
The article concludes saying those sitting on lots of cash may have a significant opportunity to pick up deals quickly and cheaply - but then you have to figure out what to do with the space.
So we now have the makes of a commercial real estate crisis. Would the current building owners defaulting spread to a residential real estate crisis?