Interview, Other
Commercial real estate risks
- Office property values are projected to decline by 40% to 45% from pre-pandemic levels over the coming years, driven by structural shifts toward remote work and cyclical pressures, with trophy assets expected to lose 20% while A-, B-, and C-class properties could depreciate by 60% or more.
- Current office occupancy rates have stabilized at approximately 50% of pre-pandemic levels according to turnstile data, with sensor data indicating actual utilization at around 30%, while cash flows have already fallen roughly 20% in real terms since the pandemic onset.
- In New York, transit ridership on mid-week days is expected to recover to 70% or 75% of 2019 levels, whereas Monday and Friday volumes will likely remain suppressed, reflecting a hybrid work norm where employees return three to five days per week.
- Multifamily markets face sustained rent pressure for several years due to a supply surge of approximately one million new units, with market stability not expected until 2025 as the sector navigates maturing loans and lease roll-offs.
- Reclassification of office stock will differentiate competitive assets near transit and with modern amenities, which will retain demand, from obsolete properties that may require conversion to other uses or demolition, similar to the trajectory of non-convenient malls.
- Only 10% to 15% of the US office stock (roughly 400,000 units) is physically suitable for conversion to housing, with successful projects requiring low acquisition costs, manageable construction expenses, and strong rental demand to achieve a 15% return IRR.
- Affordability mandates imposed on conversion projects will significantly reduce net present value, making private profitability difficult without subsidies, while the physical and financial process of reallocating space is expected to take considerable time.
- Loan maturities and valuation marks will accelerate in 2024, potentially leading to equity wipeouts in deals with 40% value declines and debt losses of roughly 30% on CMBS in Class B scenarios, with recapitalization transactions seeing loans written down to 50 cents on the dollar.
- A second regional banking crisis is anticipated over the next two years, potentially resulting in the disappearance of 500 to 1,000 smaller banks due to CRE vulnerability, duration risk, and deposit outflows, as small banks under $10 billion hold CRE exposure at 280% of equity.
- Banking systems currently hold three times more CRE exposure than in the mid-1980s, and a 10% loss in CRE values would constitute a significant shock given that large banks hold roughly 55% of their equity in these assets.
- Commercial real estate distress will coincide with structurally higher interest rates and tight credit standards comparable to the peaks of the COVID pandemic and the Global Financial Crisis, potentially triggering a mild recession.
- The full resolution of the office sector crisis is forecast to take five to seven years due to lags in lease roll-offs, refinancing difficulties, bank work-outs, and the multi-year timeline required for asset conversion, mirroring the early 1990s savings and loan crisis.
- While trades in New York currently occur at 66% discounts and San Francisco at 70% to 80% discounts to pre-COVID values, overall sentiment regarding office sector stress is expected to remain worse than reality, particularly for lower-quality buildings.