Navigating challenges in US commercial real estate
Higher interest rates and a structural shift in how people work post-pandemic are issues faced by the US office property sector
AFTER the pandemic, most companies transitioned towards hybrid working arrangements for greater cost synergies, reducing the need for large office spaces. Furthermore, the option to work remotely has become a feature that attracts and retains employees.
This structural change in how people work post-pandemic has resulted in a fall in demand for commercial real estate (CRE), particularly in the US.
Owners of US office properties were also affected by the Federal Reserve’s aggressive rate hikes last year. As prices of assets continue to descend, owners are less willing to sell at distressed values. However, they are running out of time as their loans approach their maturity dates.
Huge discounts in valuations
Some owners may have to sell assets at distressed prices. For instance, Clarion Partners sold an office building in New York City, which it bought for US$230 million about a decade ago, for US$127 million. This represents a steep loss of 45 per cent.
Moreover, defaults are rising. High-profile cases last year included Brookfield, which defaulted on a US$750 million debt on two office towers in downtown Los Angeles. Pimco-managed Columbia Property Trust also defaulted on US$1.7 billion of debt backed by a portfolio of US office assets.
As at Dec 31, 2023, distressed US properties amounted to almost US$86 billion in value, with offices comprising 41 per cent, data from MSCI showed. The potential distress, indicating a decline in an asset’s current financial standing, reached nearly US$235 billion across all property types.
BT in your inbox
Start and end each day with the latest news stories and analyses delivered straight to your inbox.
Office space prices have dropped in financial hubs from London to Tokyo, but US cities have experienced notably steep declines. San Francisco, which enjoyed high demand from technology companies for years, had the highest vacancy rate in the country in the fourth quarter of 2023 at 37 per cent, Savills reported.
Implications for other stakeholders
Concerns regarding how this situation would affect other stakeholders have heightened. Lenders such as banks could look to sell these US CRE loans to cut losses, or make more loan provisions. For instance, New York Community Bancorp has already announced net losses of US$252 million in Q4 2023 due to its US CRE loan portfolio. It has announced a dividend cut and is preserving its reserves to manage further losses.
As these commercial properties in top-tier US cities used to attract global investments, the impact is felt by lenders beyond the country. For instance, Japan’s Aozora Bank recently revised its financial outlook for the fiscal year ending Mar 31, 2024, to anticipate a net loss of 28 billion yen (S$250.2 million). This is in stark contrast with its prior forecast of a net profit of 24 billion yen, primarily due to its exposure to loans in US CRE.
Germany’s Deutsche Pfandbriefbank and Aareal Bank are facing higher unsecured borrowing costs as investors turn increasingly cautious about their problematic US loans.
Within South Korea, some local investment companies and asset managers, such as Mirae Asset Securities and Hana Securities, are major investors of US CRE. Both reported losses last year due to their exposure.
Canada’s Sun Life Financial has witnessed a sharp decline in the value of its US office investments, especially in a San Francisco building. Additionally, the Canada Pension Plan Investment Board (CPPIB) recently sold its 29 per cent stake in a Manhattan office tower located at 360 Park Avenue South for just US$1 to Boston Properties, which would also take on CPPIB’s share of the project debt.
Elevated rates add pressure
These troubles are unlikely to dissipate anytime soon. We believe the market consensus is still overly optimistic about the probability of rate cuts this year. With the resilient US economy and the uncertainties surrounding the Red Sea that could potentially drive up shipping and freight costs, inflationary pressures will be sustained.
This suggests interest rates will remain elevated, which would further exacerbate the credit crunch for the property sector.
Overall, the US CRE sector is plagued by the challenges of elevated interest rates after an era of cheap money, and a structural shift in how people work after the pandemic. Hence, with the various uncertainties, it may be prudent to trim any portfolio exposure to US CRE, such as regional banks and US office real estate investment trusts.
The writer is a research analyst with the research and portfolio management team of FSMOne.com, a Singapore subsidiary of iFast Corporation
Copyright SPH Media. All rights reserved.
