Distressed Commercial Real Estate Hits Highest Level in Ten Years

tremendousblog

Oct 19

As skyscrapers stand empty, a crisis is brewing in commercial real estate. The amount of distressed CRE hit the highest level in 10 years, according to a new report from Bloomberg.

The value of distressed US commercial real estate neared $80 billion in the third quarter, its highest level in a decade, as rising interest rates and sagging office demand shook the property market.

The value of buildings in bankruptcy, repossessed by lenders or in the process of liquidation increased by a net $5.6 billion in the quarter, MSCI Real Assets reported. Office properties accounted for 41% of the $79.7 billion total.

Landlords In a Tough Spot

As work from home continues, many office buildings are empty. Since commercial real estate loans are usually for 5 to 20 years, as opposed to 30 years in residential, many of those loans will come due in the next few years.

The interest rate on any new loan will be much higher than the old one. Can a landlord afford those much higher payments, especially with half his building empty?

And if you're a lender, why would you even make this loan? A landlord with a half empty office tower and declining rent roll isn't a good risk.

Even if a landlord wants to give up and sell, buyers are hard to find. A friend of mine who's a commercial real estate broker in New York City tells me there are no buyers for empty office space, at any price.

With rents declining, buyers few and credit tightening, I expect to see many landlords hand the keys back to the bank.

Return to Office? I Don't Think So.

There's one thing that could bail out landlords — a return to the office. But although many companies are trying to get employees back in their cubicles, they haven't had much luck.

Work from home rates have declined nationally. But that decline is concentrated in more rural states with few white collar jobs.

In the major markets, remote work still rules. Again from Bloomberg:

Average office attendance across ten big US cities remains about 50% of pre-pandemic levels, according to security firm Kastle Systems International LLC, no higher than where it was early in 2023.

My friends in New York tend to work remote about 40% of the time. If only half the company is there on any given day, office space is an easy item to cut.

What Happens to Those Empty Office Towers?

"Everyone I know is starting a distressed fund," my broker friend told me recently. Clearly there are buyers for these empty office towers, even if landlords won't like the price.

As banks repossess empty buildings, they'll be itching to get them off their books. And if the price is low enough, a conversion to residential can make sense.

These conversions are very expensive. You need to re-do the entire floor plan, add lots of plumbing, and more.

But if you can buy the building cheap enough, you can make the numbers work. And unlike offices, the demand for housing is red hot.

Wrap-Up

Having everyone in New York City converge on a single point at 9am every day is insane. And after the invention of the internet, it no longer made sense.

And yet we did it, every day!

It took a major shakeup to finally get us to take advantage of existing technology. And now that workers have gotten used to a 30 second commute and Zooms in their sweats, they're not going back.

I'd like to see these office buildings plummet in price and get converted to housing. Many are in prime locations where people would love to live.

If we get rid of hellish commutes and add reasonably priced housing, that's a win-win.

What do you think the future holds for commercial real estate? Leave a comment and let us know!

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