THE financial world is increasingly warning of the pain to come for owners of office buildings.

Investment leaders, from Apollo Global Management’s Marc Rowan to Cain International’s Jonathan Goldstein and Citigroup chief executive officer Jane Fraser gathered this week in Beverly Hills, California, for the Milken Institute Global Conference, right as turmoil with First Republic Bank peaked with its last-minute sale to JPMorgan Chase. Now, eyes are turning to another source of potential risk: commercial property.

“It’s a bad day to be an office owner in San Francisco and Chicago,” said Rowan, co-founder and chief executive officer of Apollo. “We are going to see losses,” he added, noting that the stresses will be concentrated and not systemic.

Offices have become a particular source of stress given the rise in remote and hybrid work, which has limited the prospects of filling those towers back up. The US vacancy rate for office buildings was nearly 19 per cent at the end of the first quarter, increasing for the past 13 straight quarters, according to broker Cushman & Wakefield. 

“I do think we’ve got a period of pain and I don’t think we’ve yet reached the bottom of that,” said Cain’s Goldstein. “But there will be opportunity that comes out when people do begin to sense that the bottom’s been reached.”

Rising borrowing costs are also squeezing property owners, complicating the financing for many buildings. It has led landlords including Brookfield and Columbia Property Trust, owned by funds managed by Pacific Investment Management, to default on debt. Some of the landlords have defaulted as a strategic step to kickstart negotiations with lenders.

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Vornado Realty Trust, a major owner of New York office properties, recently postponed its dividend payments until the end of the year, a move that surprised analysts and rattled investors.

David Steinbach, global chief investment officer at real estate investment firm Hines, said on Monday (May 1) at the Milken Institute Global Conference panel that commodity office buildings – older office buildings that lack amenities – would face particular pain. Amherst chief executive officer Sean Dobson pointed to office towers in central business districts as a particular rough spot for the industry.

Not all offices will suffer, according to Cain’s Goldstein. High-quality, well-located office are getting better rents, he said. Cain has partnered with OKO Group on 830 Brickell in Miami, a building that has lured tenants including Ken Griffin’s Citadel and Microsoft.

Significant dislocation

The stress in the sector is also pressuring prices. US commercial property prices fell 15 per cent in the 12 months through March, with office prices dropping 25 per cent, according to Green Street.

“Every piece of real estate, everywhere in the world, that was purchased pre-the run up in interest rates, as a result of the change in interest rates, is now worth less,” Rowan said. “It does not mean it won’t come back. It does not mean it won’t ultimately be a good investment, but in the short term, we have significant dislocation.” 

Banks including Wells Fargo have acknowledged risks in the commercial property sector, particularly for office loans. Wells Fargo said in April that it was reviewing those properties to better understand the situation. 

Citigroup’s Fraser said there is a particular risk for real estate with debt packaged into lower-rated commercial mortgage-backed securities. New York-based Citigroup is a relatively small player in the space, with just US$55 billion in commercial real estate lending exposure as of the first quarter.

As far as corporate credit goes, Rowan said he is not surprised that investors are rushing to lock in the best yields on debt in over a decade. The average US investment-grade bond yielded 5.1 per cent on Friday, according to data compiled by Bloomberg.

Rowan said now is a good time to invest in company debt and that most of the credit downgrades to junk are already priced into the market. When allocating his firm’s capital, he prefers to be at the top of the capital structure, investing in senior secured investment-grade debt, he added.

“This is an amazing entry point for credit,” he said. “Liquidity has eroded, banking crises has further eroded it. We have a unique entry point for credit. It will not always be this good. Equity has adjusted somewhat, but not nearly as much as credit.” BLOOMBERG