Jun

Concerns over loan defaults as office and retail tenants fail to renew leases

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Persistent home working is affecting office occupancy rates and is leading commercial tenants to fail to renew their office leases.

Ghost city streets have emerged post pandemic as occupancy rates hit a new low. In the UK it has been reported that these office space rates could now be as low as 36 per cent in some locations compared with an average level of above 80 per cent pre pandemic.

The Ifo Institute for Economic Research, a Munich-based research institution, one of Germany’s largest economic think-tanks, reports that on any given day, 12.3 per cent of workplaces remain unused because staff working from home.

In the US some lenders expect to take losses on real estate loans following warnings that the commercial property asset class is the sector to experience a crisis after the recent turmoil in the US regional banking industry.

Quantitative Easing

Since the start of the global financial crisis in 2008, central banks around the world continued to roll out quantitative easing (QE) measures which has resulted in dramatic expansions of their balance sheets.

The Covid pandemic further accelerated this trend as an essential monetary policy tool. The pandemic emergency purchases programmes aimed at softening the economic shocks led to government purchases of unlimited amounts of treasury and mortgage-backed securities.

Interest rates were cut to near zero pushing up asset prices to unprecedented levels, but as bank and central government unwind QE, raise taxes and attempt to contain high inflation levels by raising interest rates, all this is increasingly putting pressure on commercial borrowers and lenders.

Leases not renewed?

The problem for commercial property landlords is that vacancy rates are increasing as leases expire and fail to be renewed. There are many businesses operating with a considerable amount of spare capacity, office and retail space. Many commercial landlords and will either not be renewing their leases or will renew taking less space.

The persistent trend for office workers to work from home means that many businesses with spare office space will not be renewing their leases because their employees continue to work from home. Studies show that the trend has only partly been reversed since the pandemic, and experts are predicting that working from home will remain a feature of future office life.

A similar issue is facing many commercial retail stores in UK high streets. Many shops are facing dramatic declines in values brought on by a lack of tenant demand which is brought about by the rising trend for online shopping.

All this is making banks nervous. Landlords may be looking to restructure loans as their income streams dry up, when tenants fail to renew, and new tenants are hard to come by. In the worst case for bank lenders, landlords will simply fold leaving the lenders shouldering large losses.

In the US the commercial property market has already reached a point where some banks have been offering to sell off commercial property their loans at a big discount, even when their landlord borrowers are currently keeping up with their repayments – the banks are anticipating problems ahead and want to reduce their exposure to commercial property debt.

CoStar, a commercial property research company, thinks that a commercial real estate loan issue is looming, warning that commercial real estate could be the next crisis point in the US following the recent regional banking crisis there.

Oversupply

An oversupply of commercial buildings in some locations will inevitably lead to certain amount of re-purposing. Converted commercial buildings to residential and other uses is a trend that’s been ongoing for some time, and there are tax and planning incentives to do this.

It needs considerable new investment to implement conversions to be successful, and even when the buildings continue in office or retail use, they may need a considerable amount of refurbishment to meet the new energy efficiency standards, particularly with older buildings.

Some down town areas are struggling because of a lack of footfall, a lack of people traffic when workers are working from. This makes it all the more important that some buildings in these locations are converted to residential use to increase this all important foot traffic.

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