Real Estate

Can US offices collapse without breaking something important?

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Rui Soares is an investment professional for FAM Frankfurt Asset Management, an independent investment firm

US office market prices are 35 per cent below their peak . . . 

© Bloomberg

. . . and vacancy rates are at an all-time high:

© Bloomberg

US nationwide occupancy rates (the percentage of available office space that is being rented and effectively used) stand around 40 per cent. It’s not farfetched that following rental contract renegotiations and extensions, occupancy may drift to around 35 per cent over the next few years:

© Savills, Castle Systems Back to Work Barometer, FAM

The evolution of the number of daily passengers using the New York underground (still roughly 35 per cent below their pre-pandemic level) seems to point in the same direction:

© MTA – Metropolitan Transport Authority, *FAM estimate

At a 30-35 per cent vacancy rate, a typical US office building is structurally unprofitable:


Converting empty offices into houses is often portrayed as a potential solution to the problem. But most are not suitable for conversion.

Office buildings are often attached to each other, so lack natural light. Even when this is not the case, their layouts still make conversion unfeasible. There’s no good building giant lofts that no one can afford, or carving up floorspace into a series of windowless rooms. But inner courtyards or light shafts are prohibitively expensive to install. Then there’s the cost of replacing windows that can’t be opened, water pipes that are too small for the needs of residents, and foot traffic routes that would be unsafe. Re-zoning presents an additional hurdle, since in many US business districts no residential property is allowed.

More often than not, the building’s demolition and the realisation of the land value is the only viable option. Land value is on average around 30 per cent of the total value of a property.

But where does that leave the lenders?

Assuming that 30 per cent of the office buildings disappear and the loss given default is 55 per cent (average LTV = 65 per cent; recovery value = 30 per cent), banks would end up with losses amounting to 16.5 per cent of their US office loan exposure.

That might be too optimistic. High vacancy rates lead to lower rents across the board, impacting what would otherwise be profitable office buildings as well. So let’s say that in the mother of all distress situations, losses would amount to 25 per cent of the banks’ overall US office loan exposure. And let’s further assume that commercial mortgage-backed securities end up on banks’ balance sheets — ie, CMBS are held by bank-financed highly leveraged hedge funds, those funds implode, and 20 per cent of the CMBS loans are office-related.

Chances are, most US banks would still muddle through:

© FRED / St. Louis Fed, FAM calculations

The US banking system’s total equity is $2.3tn and it generates an annual profit of $300bn, approximately. Total losses even in the worst-case scenario outlined above would amount to $200bn. The US office market is way too small to create a systemic event — a few banks, with very high exposure to that market segment, would be insolvent but for the system as a whole not much would happen. Even spillover effects to the rest of the US CRE market would not constitute a systemic danger.

For a systemic event to arise, contagion would have to spread to the residential real estate market. There are no signs yet of this happening. On the contrary:

© Bloomberg

And even if contagion happened, the direct exposure of the banking sector to the residential RE market would be manageable — as long as the losses could be distributed over three years (hello, Fed!).

Explaining the resilience is straightforward: most of the residential RE mortgages are outside of the banking system. They are to be found in residential mortgage-backed securities. These would need to end up on the banks’ balance sheets again, à la 2007/2008, for a systemic distress event to be triggered.

And because RMBS-banking sector interconnectedness is significantly lower now than then, that’s no more than a tail risk.

Cutting a long story short: the situation in the US office market is hopeless. But it is probably not serious. Knock them down.

Further reading:
The CRE non-crisis rolls on (FT Unhedged)
Office loans ‘living on borrowed time’ (FTAV)
Colliding with the CRE’s maturity wall (FTAV)
CRE and systemic risk (FTAV)
Just how bad is office CRE anyway? (FTAV)
Peering through the window into US offices (FTAV)


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