At a time when many of the major stock markets around the world are soaring high,?owners of gleaming office?towers?from London to New York have been walking away from their debt.
For instance, the landlords of downtown San Francisco¡¯s largest mall have abandoned it. A new Hong Kong skyscraper, too, is only a quarter leased.
It's because the creeping rot inside commercial real estate is like a dark seam running through the global economy. Even as?stock markets rally, the trouble in property is set to play out for years.
After a long?buying?binge fueled by cheap debt, owners and lenders are grappling with?changes in how and where people work, shop, and live in the wake of the pandemic. At the same time, higher interest rates are making it more expensive to buy or refinance buildings.
A tipping point is coming: In the US alone, about $1.4 trillion of commercial real estate loans are due this year and next, according to the Mortgage Bankers Association. When the deadline arrives, owners facing large principal payments may prefer to default instead of borrowing again to pay the bill, as per a Bloomberg report.
The number of transactions is plunging, and when deals do happen, the price declines are stark.
In the US, where?return-to-office?rates have been lower than in Asia and Europe, values for institutional-quality offices are down 27% since March 2022, when interest rates started going up, according to data analytics company Green Street. Apartment building prices have declined 21%, and mall prices are down 18%. Office prices are expected to fall more than 25% in Europe and almost 13% in the Asia-Pacific region before hitting a trough, PGIM Real Estate, a unit of Prudential Financial Inc., forecasts.
Commercial?real estate¡¯s woes are expected to add to the stress on a financial system?that¡¯s already reeling from this year¡¯s crisis in regional banks after back-to-back failures. And as the downturn deepens, it stands to have a transformational impact on some cities as they contend with empty buildings and lower property tax revenue.
The question is whether the commercial property correction will be big enough to destabilise the wider economy. As broad as the forces arrayed against the real estate sector may be, it¡¯s also a very local business, encompassing not only urban skyscrapers but small-town shopping centres, suburban apartment buildings, and sprawling warehouse parks.
Debt distress has already stretched from?Los Angeles?to?Sweden?and?South Korea.
Here¡¯s how the troubles are unfolding in some major financial and business centres around the world:
Nowhere in the US is the crisis more pronounced than in San Francisco, where a downward trend is gathering momentum as one building after another slips into default. Property prices in the tech hub reached record heights in the past decade, so they had a long way to fall. The city boomed with hot startups¡ªAirbnb, Twitter, and Uber Technologies¡ªalong with established giants such as Salesforce. Now many of them have cut jobs and office space.?
The downtown is struggling to re-attract employers and employees who thrived working remotely. The area consists largely of office towers, leaving it feeling particularly empty. Those workers who do come in endure among the nation¡¯s longest average commutes. San Francisco¡¯s homelessness crisis is also concentrated downtown, and highly publicised retail theft has led to some stores closing.
As per the report, in the once-fashionable Union Square district, the?owners of the city¡¯s largest mall, Westfield San Francisco Centre,? essentially handed the keys over to holders of a $558 million mortgage in June.?The move came after Nordstrom Inc. announced it was closing its department store in the complex. With tourism slow to rebound from the pandemic, Park Hotels & Resorts Inc. has stopped payments on $725 million in debt tied to two of the city¡¯s biggest hotels, the Hilton San Francisco Union Square and the Parc 55 San Francisco. Veritas Investments Inc., a major local landlord, defaulted on $675 million in debt on a portfolio of apartments valued at more than $1 billion in 2020. The loans are now on the market.
The city¡¯s coffers are taking a hit, with Mayor London Breed projecting a $780 million two-year budget deficit. She¡¯s proposed diversifying the downtown, including the conversion of more buildings to housing, and suggested the Westfield mall could be used in other ways, reflecting a "new vision" for the property. For now, there¡¯s a lot of empty space to fill.
While New York City¡¯s streets are bustling with tourists and residents, only?about half of office workers are back at their desks, according to building security company Kastle Systems.
The report mentioned that many buildings are struggling with the loss of tenants and the need for upgrades. As employers work out their updated office needs, they can choose spaces in newly built towers in such areas as Hudson Yards or near Grand Central Terminal rather than ageing properties.
These choices helped put even iconic buildings in the world¡¯s financial capital into troubled situations. At the Seagram Building, a 1950s skyscraper in Midtown that¡¯s renowned architecturally for its modernist design, owner RFR Holding had to?negotiate a one-year extension on $1 billion of debt set to mature this year?after failing to secure financing. RFR spent $25 million on upgrades, including a vast sports complex and a wellness centre, and the property was 95% leased as of earlier this year. Still, it lost Wells Fargo to a newer development prior to the pandemic, while private equity firm Clayton Dubilier & Rice is relocating to a renovated Madison Avenue tower.
New York's Mayor Eric Adams has called for a wider return to the office, urging Wall Street leaders to enforce more in-person work. Offices, expected to reach a record 22.7% vacancy rate this year, typically account for about 20% of the city¡¯s property tax revenue. A joint study by researchers at New York University and Columbia University found that offices in the city will lose 44% of their pre-pandemic value by 2029 because of the impact of remote work.
The widespread adoption of hybrid work is hitting London?unevenly.?Office vacancy rates in London¡¯s West End, home to the city¡¯s buzziest retail and nightspots, are almost at record lows as companies look for space in the best buildings and locations to help lure workers back. Rents are rising, too, because companies are prepared to pay more per square foot while taking less space overall.
The Canary Wharf district, home to 1990s-era glass and steel towers, is in the deepest trouble. The neighbourhood, perceived by most as a place built solely for bankers, is having a harder time staying relevant for major office tenants. The law firm Clifford Chance is leaving in favour of a new¡ªand much smaller¡ªoffice in the more centrally located City of London district. HSBC Holdings Plc is looking for a new headquarters, with most of its shortlisted options in the City as well. The YY building, a recently completed redevelopment of Thomson Reuters Corp.¡¯s former headquarters that occupies the prime site right outside the Canary Wharf tube station, remains entirely vacant.
Another issue looming over London¡¯s real estate market is the prospect that hundreds of buildings will be rendered obsolete because they don¡¯t meet UK environmental regulations. Properties are graded on energy performance, from A to G.?
By 2030, it will be illegal to rent commercial buildings that are ranked below B. That leaves landlords forced to make costly upgrades or risk their offices sitting empty. Brexit has also contributed to London losing some of its financial allure, says PGIM¡¯s Hayes. Office buildings are "very, very vulnerable for the near term," he says.??
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In 2015, a 26-floor building with a sweeping view of Hong Kong¡¯s famed Victoria Harbour made headlines in the city when China Evergrande Group reportedly purchased it for $1.6 billion¡ªmore than double the previous record for an office tower. The deal exemplified the property market boom in the Asian financial hub, which in the years that followed attracted ambitious Chinese capital to buy everything from office blocks to land plots, often at record-breaking prices. Investing in offices appeared to be a safe bet in a city with tight space and strong demand from mainland Chinese companies.
But then came anti-government protests and the strict lockdown measures of Covid-19 in 2020, which made investors rethink Hong Kong¡¯s status as a financial hub. Adding to the turmoil: a Chinese property debt crisis, with Evergrande at the center.
With hundreds of billions of dollars in debt, the developer sought to raise cash in every way possible and, in late 2020, pledged the office building to a bank in return for a HK$7.6 billion ($971 million) loan. Last year, a receiver took over the property. The new owner put the building up for sale but failed to get a bid that reached its target. The tower is now only about 25% occupied, in part because prospective tenants are put off by its complicated ownership. It was fully occupied when Evergrande bought it.
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