A great threat looms over US banking, the office crisis. Demand has plummeted due to teleworking and interest rates and, consequently, the vacancy levels of commercial properties are skyrocketing. The value of offices has fallen by up to half in some cases (12% globally) and this could represent a ticking time bomb due to a possible wave of defaults. Both the largest banks in the country and the smallest are preparing liquidity to take on this scenario… but other types of companies are seeing a great opportunity in the current situation: funds of all kinds are flocking to buy offices.
The last to do so was the Norwegian Sovereign Fund itself, which has purchased 98% of the property of the large offices in Menlo Park (San Francisco) for about 217 million dollars. The rest of the participation corresponds to the local promoter DivcoWest. In addition, Norges Bank has carried out this operation at random. “The asset is not encumbered with any debt and there was no type of financing involved in the transaction,” it stated in a statement.
However, the case of Melo Park is not the only one. Although Norges Bank’s move has been by a true giant, Colliers warned that they are seeing an aggressive entry by “small private equity companies.” This is seen more specifically in the Preqin data, which shows that of the 400 billion dollars invested in the sector, investments in the US have already reached 64%, the highest proportion in two decades.
Refinancing and sales volumes are already picking up as sentiment around the sector improves, according to Willy Walker, chief executive of commercial real estate finance firm Walker & Dunlop. This October, in fact, the first increase in transactions from 2022. According to data from Altus Group, these increased by 13.9% in one fell swoop to $40 billion.
In the latest Deloitte survey, published in early October, 880 global CEOs They commented that “we see signs that 2025 will emerge as a year of great recovery after two very complicated years.” 88% of those surveyed assumed that they expect income to grow in the next twelve months and believe that they will achieve returns above 5% year-on-year.
The keys to the ‘comeback’
JP Morgan agrees that there are high hopes that prices will rise and the sector will accelerate. “Prices have fallen 12% since September 2022“This is the largest decline since the Lehman Brothers crisis (-24%), after which, precisely, there was an upward correction over time. In some assets, prices have fallen by up to 40%. The firm defended in its report that “we are optimistic, this decline generates unique potential opportunities.”
The North American bank explained that the first and clearest is “that the values of these properties have fallen but their cash flows have remained the same”. They point out that the capitalization rate (the return offered by an asset) is 5%. A combination of factors that “suggest substantially higher returns” and believe that in the future the current situation will generate a supply/demand mismatch that will favor these rentals, just as happened in 2008.
“Supply is likely to be limited for years to come, which will support prices”
“Supply and demand point to higher prices in the future. Supply is linked to expected demand and the crisis has caused office construction to fall by 75% from its peaks.” Construction is a process that requires time and has long delays in the face of demand, so “it is likely that supply will be limited during the coming years, something that will support prices but, above all, will translate into higher cash flows.
Especially taking into account the good performance of the US economy, which “is close to its maximum capacity, with a capacity of unemployment about 4%“So, although there are problems with interest rates and teleworking, a situation of practically full employment and high incomes “will boost demand from companies that find that commercial real estate is at its lowest levels in the world. last 5 years.”
Although they undoubtedly believe that the decisive factor will be the rate cuts by the Fed. “The price of a property and the valuations of commercial goods are based on appraisal and cash flows These factors are largely based on “cash flows (derived from interest rates) and owner leverage.” In both cases, these factors should improve as the Federal Reserve lowers rates further.
“Not all assets are equal, it will be an uneven recovery”
“Nowadays, we see fewer buyers and sellers in the market as result of high interest rates“. Therefore, “amid resilient cash flows, these other two components should improve as the Fed begins its rate cutting cycle in the second half of 2024.”
Goldman Sachs also expressed the idea that it sees opportunities but believes that the asset must be chosen well. “The fact that there are some problem properties with a very high vacancy rate (is at 20%) and a problem with the cost of capital or the cost of debt does not mean that the entire asset class has a problem,” said Lindsay Rosner, director of multi-sector investments at the firm. “What we have been able to do is find a lot of opportunities in commercial mortgage-backed securities.
The Fed’s policy change is “the most notable green shoot,” Wells Fargo experts commented in their latest report, noting that (although it may take longer), the cuts are “laying the foundations for a recovery”. From Bank of America they especially emphasize that “despite the fact that the recovery of commercial real estate is already underway.”
Extraordinary bargains in indebted offices
Beyond buying assets themselves. The big bet for many is in acquiring the most indebted. Although they can be a burden, the bet is to take these undervalued assets and hope for a recovery over time and a decrease in the cost of debt with rate cuts by the Fed. In this context venture capital companies They are considering that the current paradigm generates a unique opportunity. If they buy devalued assets exposed to debt they may find themselves facing great danger but, if the situation reverses (in particular interest rates fall) they will have an enviable portfolio for a ridiculous price.
This strategy is fraught with risk since almost 1 trillion of debt linked to these assets matures in 2024, according to data from the Mortgage Bankers Association. It is very easy for non-payments to begin to emerge as due dates arrive. Asset manager PGIM estimates a gap of almost 150,000 million of dollars between the volume of loans maturing and the new availability of credit this year.
In any case, Deloitte comments that “the imminent expiration is not insurmountable” since the better context has generated “alternative options, such as private credit. Of course, the consulting firm recognizes that “bank loans are likely to continue to be more moderate compared to previous levels, as they manage exposure to the sector in the midst of the regulatory scrutiny.” In summary, the regional banks most exposed to these assets until now will not want to have such a presence in a market that is not without great dangers for their balance sheets. However, “for other companies with lower leverage there may be an open window. “Especially as rate cuts open the door for buyers to return.”
John Brady, global director of real estate at Oaktree is clear that “We could be on the verge of one of the distressed real estate investment cycles “Few asset classes are as underappreciated as commercial real estate, and therefore we believe there are few better places to find exceptional bargains.” “When you start to get into the cycle, the big market is where people find the opportunities,” John Graham, chief executive of the Canada Pension Plan Investment Board, said in an interview. For everything from private equity to private credit and commercial real estate, “the United States is the largest market.”
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