A great threat hangs over the American banking sector: the office crisis. Demand has fallen due to telecommuting and interest rates, commercial property vacancy rates are skyrocketing. Office values have fallen by up to half in some cases (12% globally), which could pose a ticking time bomb due to a possible wave of defaults. Both the largest and smallest banks in the country are preparing liquidity to face this scenario… but other types of companies see the current situation as a great opportunity: funds of all kinds are flowing in to buy office space.
The last to do so was the Norwegian Sovereign Fund itself, which purchased 98% of the property large offices in Menlo Park (San Francisco) for approximately $217 million. The rest of the stake corresponds to local developer DivcoWest. Furthermore, Norges Bank carried out this operation randomly. “The asset is not encumbered by any debt and no type of financing was involved in the transaction,” it said in a statement.
However, the Melo Park case is not the only one. Although the Norges Bank move was made by a true giant, Colliers warned that it was seeing an aggressive entry by “smaller private equity firms”. This is most notably seen in the Preqin data, which shows that of the 400 billion dollars invested in the sector, investments in the United States have already reached 64%, the highest proportion in two decades.
Refinancing and sales volumes are already accelerating as confidence in the sector improves, according to Willy Walker, chief executive of commercial property finance firm Walker & Dunlop. In October, in fact, the first increase in transactions from 2022. According to data from the Altus group, these increased suddenly by 13.9%, to reach $40 billion.
In the latest Deloitte survey, published at the beginning of October, 880 global CEOs They said that “we see signs that 2025 will emerge as a year of great recovery after two very complicated years.” 88% of respondents believe they expect their income to grow over the next twelve months and believe they will achieve returns greater than 5% year-over-year.
The keys to “return”
JP Morgan agrees that there are high hopes for prices to rise and the sector to accelerate. “Prices have fallen by 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 fell up to 40% The company 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 fell but their cash flow remained the same”. They point out that the capitalization rate (the return offered by an asset) is 5%. A combination of factors that “suggest significantly higher yields” and estimate that in the future the current situation will generate an imbalance between supply and demand that will favor these rentals, as happened in 2008.
“Supply may be limited in the 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 caused office construction to fall 75% from its peaks. » Construction is a time-consuming process with long delays in the face of demand, so “it is likely that supply will be limited over the next few years, which will support prices but, more importantly, result in higher cash flow.
Given in particular the good performance of the American economy, which “is close to its maximum capacity, with a capacity to unemployment around 4%“So, even if there are problems with interest rates and teleworking, a situation of near full employment and high incomes “will stimulate demand from companies who see that commercial real estate is at its highest levels. lowest in the world.
Although they undoubtedly believe that the deciding factor will be the Fed’s rate cuts, “real estate prices and commercial property valuations.” are based on valuation and cash flow These factors rely largely on “cash flow (derived from interest rates) and owner leverage.” Either way, these factors should improve as the Federal Reserve lowers rates further.
“All assets are not equal, the recovery will be uneven”
“Nowadays we see fewer buyers and sellers in the market because result of high interest rates“. Therefore, “against a resilient cash flow environment, these other two components are expected to improve as the Fed begins its rate reduction cycle in the second half of 2024.”
Goldman Sachs also expressed the view that it sees opportunities but believes the asset must be well chosen. “The fact that there are problematic buildings with a very high vacancy rate (is 20%) and a problem with the cost of capital or the cost of debt doesn’t mean the entire asset class has a problem,” said Lindsay Rosner, the firm’s director of multi-sector investments. “What we do What we’ve been able to do is find a lot of opportunity in commercial mortgage-backed securities.
The Fed’s policy shift is “the most notable kickoff,” Wells Fargo experts commented in their latest report, noting that (although it might take longer), the cuts are “lay the foundations for a recovery”. From Bank of America they particularly emphasize that “despite the fact that the recovery of commercial real estate is already underway.”
Extraordinary business in debt-ridden offices
Beyond purchasing assets themselves. The big bet for many is to acquire the most indebted ones. Even if they can constitute a burden, the bet is to take these undervalued assets and hope for a recovery over time and a reduction in the cost of debt with the Fed’s rate cuts in this context. venture capital companies They consider that the current paradigm generates a unique opportunity. If they buy devalued assets exposed to debt, they may face great danger but, if the situation reverses (especially a fall in interest rates), they will have an enviable portfolio for a ridiculous price.
This strategy is fraught with risk since nearly $1 trillion in debt tied to these assets matures in 2024, according to data from the Mortgage Bankers Association. It is very easy for delinquencies to begin to appear as due dates arrive. Estimates from asset manager PGIM a gap of almost 150 billion of dollars between the volume of maturing loans and the new availability of credit this year.
Regardless, Deloitte comments that “imminent expiration is not insurmountable” since the best context has generated “alternative options, such as private credit”. Of course, the consultancy acknowledges that “bank lending is expected to continue to be more moderate compared to previous levels as it manages exposure to the sector in the midst of the crisis.” regulatory control. » In summary, the regional banks most exposed so far to these assets will not want to have such a presence in a market which is not without great dangers for their balance sheets. maybe an open window. “Especially since rate cuts open the door to the return of buyers.”
John Brady, global head of real estate at Oaktree, is clear: “We could be on the brink of one of the distressed real estate investment cycles “Few asset classes are as undervalued as commercial real estate, and so we believe there are few better places to find exceptional bargains.” “When you start to get into the cycle, the broad market is where people find the opportunities,” John Graham, executive director of the Canada Pension Plan Investment Board, said in an interview that for everything from private equity to private credit and commercial real estate, “the United States is the largest market.”
