The US office market faces a tough road ahead. Corporate tenants are considering scaling back, higher interest rates are hurting valuations and many property owners face looming debt maturities that they may struggle to refinance. That’s all concerning, but just how bad can it get? Private and public markets disagree to a jarring extent, and the truth is probably somewhere in the middle.
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First, consider the physical market, aka the real world. The Covid-19 pandemic unleashed drastic changes in the form of remote and hybrid work, and they’re turning out to be surprisingly durable. Office badge-ins are still well below pre-pandemic levels, and many companies are reconsidering their real estate needs. Others are reallocating employees to parts of the Sun Belt to address changing geographic preferences. And that comes, of course, amid an unprecedentedly fast jump in the Federal Reserve’s key interest rate and now a potential bank credit crunch. Already, Brookfield Corp. and Pacific Investment Management Co. have defaulted on office mortgages in recent months, and there’s a looming wall of around $180 billion of office mortgages coming due in 2023.
Somewhat surprisingly, this hasn’t — as of yet — had an extreme effect on office property values themselves. The NCREIF Office Property Index has lost just about 5.4% from its peak in mid-2022. As Rich Hill of Cohen & Steers explained on a recent episode of Odd Lots with Joe Weisenthal and Tracy Alloway, buyers and sellers are in a form of standoff.
At the early start of a correction, sellers don’t want to sell at the level buyers want to buy. There’s a huge bid-ask spread between the two. It’s sort of like the grieving process: There’s denial, anger, and then acceptance.
Ultimately, the market can’t go down much if it’s essentially frozen.
Next, there are public markets — the real estate investment trusts that trade on stock exchanges — where investors aren’t waiting around to see how this plays out and have been selling almost indiscriminately. The Bloomberg REIT Office Property Index is down by about half from its 2022 highs on a total return basis. For much of last year, this was a reflexive and haphazard reaction to higher government bond yields.
Read the full article here by Jonathan Levin, Advisor Perspectives.
