Are we in a CRE Crisis?

In our latest monthly Bizletter, we shared our recent blog by our Broker, Bob Gibbons, SIOR, CCIM. Every month he provides different insight into the commercial real estate market and we wanted to share this with you as well. We use our social media platforms to share our REATA Commercial news on multiple channels, but we welcome you to subscribe to our monthly BizLetter. Click here, scroll down to the bottom of the home page, enter your email address and voila!

You can also watch our podcast show, Confessions of a Recovering Landlord, hosted by our President, Jan Gibbons and Bob where they both discuss trending topics. Be sure to subscribe to our YouTube channel so you received a new notification when a new podcast episode has been posted.

We hope you enjoy our latest blog below.

******************** CRE CRISIS? ********************

Office towers in the heart of the country's biggest cities have always been the gold standard of commercial real estate. Now, owners of all but the newest and best buildings and the banks holding their debt are locked in a negative feedback loop of higher interest rates, expiring mortgages, sinking values and vanishing liquidity. Without some sort of intervention or assistance from federal regulators or a bailout from elected officials, some say the office sector could collapse — and drag regional banks down with it, causing a broad financial catastrophe.

Is this valid? If the government steps in to bail out CRE, where does it stop?

Reasons for this potential collapse are rooted in a supply glut of office space as remote/hybrid work has become the norm. Even as office occupancy indicators have remained stable for weeks, many tenants on long-term leases still have yet to make final decisions on how much space they need, but many of them will need less. The fundamentals of office leasing have changed, and it's unknown what will happen.

Transaction activity remains too scarce to build a consensus on just how much value the office sector has lost, but there is enough data to say with some certainty that the loss will be significant and permanent due to reduced demand. Office real estate values have dropped by 25% in the past 12 months, according to Green Street's March 6 Commercial Property Price Index report. A study published in November by researchers from New York University and Columbia University estimated that permanent shifts in work habits have destroyed $413B of value for the overall U.S. office market. The effect is more acute within central business districts than in suburban markets, in part because commutes to urban cores take the longest and cost the most on average.

But most markets have ebbs and flows – why should the government step into a natural cycle??While most people would say this isn’t a natural cycle, I think it’s a combo of the pandemic, government’s response to that (i.e. go home, take the shot and here’s some free money), federal reserve’s continued raising of the interest rates and right-sizing of the market.?WFH was already beginning prior to covid, the pandemic was just an accelerant.

The collapse of the commercial real estate sector could have far-reaching consequences, including a negative impact on regional banks. The commercial real estate lobby's immediate priority is convincing regulators to provide assistance and not to tip the situation into disaster. Even if the Federal Reserve can somehow thread the needle between fighting inflation and stabilizing capital markets, obsolete urban office towers still represent a long-term existential crisis for central business districts. Shrunken tenant demand and the resultant flight to quality are destined to turn at least a few big buildings in every major city from key sources of tax revenue to potential blight magnets.

To mitigate the damage to civic health, office-to-residential conversions will be in high demand wherever possible, but such transformations are tricky to finance even in the best of times. Industry groups are already gearing up to focus their lobbying efforts with Congress on some form of financial support or incentive program for conversions.

Conversions take a long time and there certainly isn’t enough time to solve the $270B in commercial real estate debt scheduled to mature in 2023 — an all-time record, credit monitoring firm Trepp reports.

Some of the richest owners of U.S. trophy office buildings with maturing debt have already turned the keys over to lenders, indicating that they see the writing on the wall. With loans maturing, higher interest rates, and low tenant demand, there is no obvious way to refinance them.

This is a great time to NOT be an office landlord.

What about tenants? There should be opportunities ahead for those tenants that need office space especially if they need less space and are willing to lease in older buildings. The key is to work with an advisor that exclusively works with corporate users and not landlords. Look around and have as many options as possible. Check the landlord’s credit and loan status to be sure they can fund the costs of your new lease. And finally, structure the lease in such a way minimizes risk should the landlord run into trouble.

As always, we’d love to work with you and welcome your referrals to other companies you know that lease office, medical and warehouse space.

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REATA Commercial Realty, Inc. is a user advisory firm exclusively representing companies and non-profits in real estate decisions - new leases, expansions, renewals, renegotiations, purchases, and dispositions of excess space. After 20 years representing landlords of office buildings throughout the US, Bob Gibbons left the landlord side of the business in 2004 to exclusively serve users.