Year of the Phoenix
The living sector eclipsed offices in 2023, but despite some anticipatory short term volatility, the tailwinds for the office sector look positive. More Phoenix than Dragon.
?
?
Last summer, the panoramic vista from the observatory atop Manhattan's Hudson Yards found itself veiled in the haze caused by distant wildfires in Canada. This was taken as a symbolic omen for high rise offices and the negative impact unconnected events have on the sector. Concerns about remote working were casting a pall over future office demand. However, this once-obscured view is now clearing, and Jeff Blau, Chief Executive of Related, one of the largest US developers, is optimistic. “We’ve had some of our best leasing over the last 12 months in the middle of all this period of time when everyone says the office is dead.”?
Wall Street Journal reporter Katherine Clarke recounts an episode in her book “Billionaires’ Row”, having paid a record $1.4 billion to buy the GM building; the most ever paid for skyscraper in United States on a highly levered deal, lenders began circling Harry Macklowe after the onset of the GFC. There was one intense board meeting where Macklowe and his broker, Darcy Stacom, dubbed the Queen of the Skyscrapers, left the boardroom to go for a walk. “Macklowe looked at the broker, his eyes moist with tears. “Is it really that bad?” he asked her. “Harry,” she said, “it's worse.” In a sign that a new office market is emerging, Stacom, is reportedly leaving the brokerage firm she worked for for 22 years to start a boutique advisory firm.?
However, there is still some pain to be felt. U.S. Treasury Secretary Janet Yellen told a House Financial Services Committee hearing that refinancings of commercial real estate loans coming due amid higher interest rates and high vacancies due to shifting work patterns “is going to put a lot of stress on the owners of these properties.” Yellen believes that the situation is “manageable, although there may be some institutions that are quite stressed by this problem.” Similarly, according to Tobias Adrian director of the IMF’s monetary and capital markets department, office blocks and shopping malls lie at the centre of the IMF’s worries over the health of lenders’ real estate portfolios.
领英推荐
Two such well documented stressed institutions are Japan’s Aozora Bank which blamed souring office loans in the U.S. as it forecast its first full-year loss since 2009, and New York Community Bancorp, which said it had lost $260m in the final three months of 2023. Bancorp, having acquired the troubled Signature Bank during the regional banking turmoil in the previous year, cited anticipated losses linked to US office building loans. The broader concern is underscored by Fitch's recent forecast, predicting a surge in delinquencies for commercial mortgage-backed securities in the US from 3.3% to 8.1% in 2024.?According to data from the Mortgage Bankers Association there are $117bn of commercial mortgages tied to offices which either need to be repaid or refinanced in 2024.
There are signs that we are moving on to the next market phase as new capital emerges to pour water on the smouldering ashes. One of New York's prominent property developers, RXR, led by Chief Executive Scott Rechler, is embarking on a $1bn fund aimed at investing in distressed office buildings within the city. Collaborating with Ares Management, they anticipate a new office landscape market where property owners are prepared to unload assets at a potential loss. “We have clarity as to where rates are, we have clarity about the future of offices, and which buildings are going to be competitive, and we have a capitulation, I think, to a recognition that values aren’t just bouncing back like they did in ‘08,” said Rechler. “There’s a reset and that this is more permanent.” RXR and Ares plan to focus on a subset of office buildings in the city that still possess appeal but may require fresh capital for competitiveness or debt restructuring to align with the new landscape of higher interest rates and slower rent growth. In this evolving market, often referred to as ‘trifurcation’, these buildings stand between the latest modern towers, fetching premium rents, and an expanding list of ageing offices rapidly becoming obsolete.?Craig Snyder, an Ares partner, said that “the broad, indiscriminate flight of institutional capital from the office sector has resulted in many high-quality properties trading down to historic lows,” and that the partnership was “hoping to identify long-term winners”.
In the UK, banking on a forbearance is still an effective strategy. Citypoint, owned by Brookfield and one of the first skyscrapers in the City of London, agreed to a one-year extension on a ￡368m loan in exchange for a 0.35% increase in the senior loan margin. The Canadian investment giant purchased Citypoint for ￡561m in 2016. There is an additionally ￡92m mezzanine loan secured against the building, bringing the total debt to ￡460m. Citypoint had an 18% vacancy rate as of October, with an annual rent of ￡32m. At a revaluation in March 2023, the value had dropped 10% to ￡670m. This may seem to provide a lot of headroom, but Five Churchill Place in Canary Wharf, a former Bear Stearns office owned by Chinese investor Cheung Kei Group that fell into receivership last year, is to be sold for ￡110m, a 60% discount to its last sale price.
The sale, which has not been finalised, will also set a significant benchmark for pricing several buildings in Canary Wharf, the iconic east London office district. Five Churchill Place is one of at least three Canary Wharf buildings that are likely to be sold. The head of Qatar’s $450 billion sovereign wealth fund said that whilst he’s concerned about the commercial real estate market they will continue to support London’s Canary Wharf Group project as a long-term shareholder. The sector contains “a little bit of risk” because of the “leverage and cost of funding,” Mansoor Al Mahmoud, Chief Executive Officer of the Qatar Investment Authority said in a Bloomberg Television interview. This sentiment is shared by the stewards of Canary Wharf who has shepherded it into a destination that extends way beyond just offices. In a Financial Times interview with the chairman of Canary Wharf, George Iacobescu, over the weekend, Iacobescu remonstrated that he was untroubled about Canary Wharf's future. “Where once the Wharf hosted a handful of isolated office towers let to big banks, it's now a fully-fledged district of London with a mix of offices, housing, shops and restaurants. The estate will continue to change uses, but the pressure of urban population growth” means that “Canary Wharf is no more endangered of becoming obsolete than the City.” Like the district needs to be seen in context, so does the office sector.?
UK investors did have their fingers burnt in 2023 though. The average total return for UK property came in at -1.0% for the year, according to MSCI. Industrial investors did okay, making a 4.1% return, but office investors saw an average value drop of -14.1% and total return of -10.2%. The embers in the office sector may still be hot enough to bring further pain in 2024 due to the remaining bid-ask spread. “For the market to start functioning again, the gap between what buyers are willing to pay and what sellers expect needs to come down significantly in the UK, especially in the London office market,” Head of European Research at Green Street, Peter Papadakos said. Green Street has pegged the bid-ask divide at about 15% on average in the UK.
Craig Wright of Abrdn thinks that sellers will be forced to take a hit and leave buyers with attractive acquisition targets: “big market dislocations tend to create once-in-a-cycle opportunities, and we believe 2024 and 2025 will be good years for buyers of core real estate. Prime offices which we categorise as “future-fit” and sustainable will have repriced by 100 to 150 basis points, depending on the specific market in Europe, and will look better value to institutional investors in light of lower interest rates.” Evidence that the divide may be bridged comes from German investor Edge which is entering into talks to buy a prime Amsterdam office building at an 8%+ yield.
Elsewhere in the world, a similar picture is emerging. For example, BlackRock Inc. is seeking to sell an office complex in Shanghai at about a 30% discount to its purchase price. Such falls might be thought of as a signal that offices have had their day. That’s not necessarily true. Although investment in the living sectors reached €43.1bn in 2023 according to JLL, eclipsing for the first-time that of offices; as Mitch Albom wrote, “what's wrong with coming second?” Cathy Marcus, co-chief executive at PGIM Real Estate recently said in reference to REITs that “the public markets have overcorrected, potentially pricing in everything and then some”. She notes public markets’ tendency to sell indiscriminately, without a close analysis of each property a REIT owns. “[public markets aren’t] differentiating enough between office Reits that hold B-tier assets and office Reits that hold A-tier assets.” Investors need to become a lot more discriminating though and we are starting to see a rebirth of the office product and sector. The ancient Greeks and Egyptians described a mythical and immortal bird called the Phoenix, which cyclically regenerates or is otherwise born again. Offices will once again be reborn amidst the metaphorical ashes of Californian wildfires, and empirically in the case of investor allocations.