Opinion
Bankers’ preoccupation with the deeply troubled state of the office market has only intensified as they’ve watched some New York office towers being offloaded at hefty discounts.
For months, the most pressing topic of conversation for bankers – whether in Manhattan, London, Stockholm or Sydney – has been how the collapse in commercial real estate values will spill over into the financial sphere.
Bankers’ preoccupation with the deeply troubled state of the office market has only intensified as they’ve watched some New York office towers being offloaded at hefty discounts.
Bankers are busily debating whether the Fed will bail out smaller US banks hit by the troubled office market. The New York Times
Silverstein Properties is selling a 20-storey office building on Fifth Avenue for $US105 million ($157 million), $US66 million less than the amount Silverstein refinanced the building for in 2020.
Alternative asset giant Blackstone has sold a 49 per cent stake in One Liberty Plaza at a valuation of $US1 billion, a steep discount to the $US1.5 billion valuation it carried when Blackstone bought the stake in 2017.
Then there was RXR, which defaulted on a $US240 million loan on its 33-storey office tower in Lower Manhattan. The property developer plans to transfer the ownership of the office tower to whoever buys the defaulted debt.
Of course, not all office towers are facing such steep discounts. Some well-situated trophy properties continue to command high rents from their corporate tenants.
But bankers estimate that values of less desirable office buildings – those that are less well located, require refurbishment, or have lost their anchor tenants – have dropped by as much as two-thirds.
As a result, they fear that this commercial property crisis will be even worse than in the 2008 financial crisis, as reduced demand for office space collides with soaring interest rates and falling property values.
They point out that real estate borrowers have seen their cost of capital double, or even treble, as the US Federal Reserve has increased interest rates and corporate borrowing spreads have blown out. This surge in borrowing costs has dragged property values lower.
At the same time, average city office occupancy has tumbled, as most companies have settled into a hybrid work strategy that allows employees to work a portion of their week from home. And this has eroded demand for office space.
The problem is that about $US1.5 trillion in commercial real estate debt – much of which was written at interest rates of 2.5 per cent – is expected to come due for repayment over the next three years.
And this has fuelled intense speculation about which banks are most at risk of suffering big losses because they have too many office loans on their books.
The consensus is that smaller, US regional banks, and some European lenders, are most at risk from their heavy exposure to commercial real estate. Smaller US lenders account for close to 70 per cent of the country’s commercial real estate loans.
Bankers point out that maturing commercial real estate loans will probably be difficult to refinance since most lenders are already tightening lending standards. A rise in defaults would further sour the commercial real estate market, as distressed sales push property values even lower.
Smaller US lenders could easily see their capital wiped out if they’re forced to take big losses on their commercial real estate loan books. And this in turn would result in a big credit squeeze for the US economy.
But the big question that bankers are debating is the likely response from the US Federal Reserve.
Some believe the Fed would have little option but to bail out troubled smaller lenders to prevent turmoil in the banking industry from pushing the US economy into recession. They believe the Fed will intervene in much the same way as it did in March after the collapse of Silicon Valley Bank.
The other alternative – which is preferred by the banking and real estate industries – is for the Fed to reduce the pressure on borrowers by pushing official interest rates back close to zero.
The trouble is that stubbornly high US inflation makes it near impossible for the Fed to contemplate slashing interest rates.
Indeed, investors are bracing for the Fed to raise interest rates later this month, amid signs that buoyant demand for US workers is ramping up wage growth, which in turn is fuelling inflation.
Meanwhile, Australian bankers are relatively relaxed about their exposure to the local commercial real estate market. They point out that Australian office buildings have suffered much more modest declines than seen offshore, falling by between 10 and 20 per cent.
Last week, AustralianSuper, the country’s biggest superannuation fund, said it had written down some of its office tower investments by as much as 10 per cent. Other industry super funds have cut the carrying value of their investments in office towers by 10 to 15 per cent.
What’s more, local bankers argue that for the past few years they’ve adopted a much more cautious approach when lending for commercial real estate. As a result, second-tier lenders have become a more important source of funding for commercial property developers.
But bankers point out that these second-tier lenders will probably find it harder to raise funding as commercial property prices fall, and the market becomes more illiquid.
Other bankers are surprised that local office building valuations have not fallen further, given local borrowers also face a steep rise in borrowing costs, and local occupancy rates have also been affected by the increased popularity of working from home.
This, they argue, could reflect the fact that holders of Australian office towers are in a stronger financial position, which means that they haven’t been forced to offload properties at hefty discounts.
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