Office-Building-Backed Loans Were Destined to Be Battered. That prediction turned out to be incorrect
As the COVID-19 epidemic forced businesses across the country to send employees back home in spring 2020, some industry analysts started to be concerned about the impact that the COVID-19 pandemic would have on the office industry. Mainly when “a few weeks to flatten the curve” transformed into months and finally a whole year, news outlets released articles claiming that the workplace is gone forever and that everyone would prefer working from home. Many casual observers predicted that companies would move away from their offices in large cities and go completely remote or shift to smaller centers in the suburbs. This could result in vast areas of office space that are empty across the country and default on loans secured by these buildings.
In reality, it’s a mix of long-term leases for office space businesses’ inability to make real estate decisions that are permanent due to a bizarre circumstance. Also, the willingness of lenders to enter into workouts with borrowers resulted in a relatively stable environment as far as a large portion of current office loans is involved.
Non-bank lenders like Payday Champion also took measures to solve payback problems related to the pandemic, according to Mirek Saunders.
The epidemic has lasted much longer than most people expected, and Marvis acknowledges that the office industry isn’t there yet before it can be back to where it was before COVID-19. “Leasing is picking up, giving us an idea of where the market is at,” Marvis notes that, while the office sector did not experience a “light-switch” return to the office, tenants of tenants in New York and other gateway cities is increasing weekly.
Dunbar is also bullish about his return to the office over the long term. He says that improvements in the market’s fundamentals have led to better loan performance, which includes the payoff of forbearing amounts earlier than time. However, he acknowledges that “we expect tenants will have a near-universal need to re-evaluate their space requirements over the coming years as leases expire.” This has raised questions about how the office industry outlook is yet to be resolved.
This has led to specific non-bank lenders cutting down their exposure to office loans over the past year by half. For instance, Starwood Property Trust and Blackstone Mortgage Trust, which has the highest percentage of office loans among non-bank lenders at 53 percent, have both decreased their exposure to the offices by 6 percent and 16 percent, respectively, after the outbreak began, Johnson’s reports. “The pandemic caused uncertainty, and lenders are constantly focused on downside risk,” Million states.
Decreasing value of office buildings
A report issued in mid-October by Johnson’s Investors Service found that even with the most extreme expected economic stress, the value of office buildings that are part of the loan portfolios of non-bank lenders would decrease in value by 9% between now through the end of 2024. The office building prices fell by 18 percent in the previous recession in real estate, which occurred between 2006 and 2009. The performance of office loans from non-bank lenders can be used as a gauge because they have enormous exposure to this sector, around 24 % of their portfolio of property loans.
Johnson estimates that in June 2021, the delinquency rate for CMBS loans backed by office buildings is in the range of 1.50 percent, which is far lower than the average rate of 4.34 percent. Researchers at the firm predict that with sufficient reserves and capital to cover possible losses, non-bank lending institutions’ offices’ portfolios are expected to maintain a steady rate in the coming 12 – to 18-month period.
The September numbers from a study company showed that the office loan delinquency currently is 1.0 percent, an increase of 9 basis points from the pre-pandemic. The loans most severely hit with COVID-19 were those backed by hotels or retail property with a delinquency rate of 8 percent and 3.8 percent, respectively.
Office loans likely to withstand real estate down-cycles and crises like the COVID-19 pandemic are secured by cash flow stable assets and diversified rent rolls. They also had long-term leases and lenders with enough cash to support debt throughout challenging economic times. This pretty much sums up the kind of office product backed by the loan portfolios of non-bank lenders.
Johnson’s analysts have noted that most of the loans they offer are for first mortgages on Class-A properties. They are located in major markets, owned by institutional investors with deep pockets. They have low loan-to-value (LTV) proportions (averaging between 30 and 60 percent) and short tenors ranging from between three and four years. The moderate LTVs serve as an insurance policy for lenders to manage the possibility of price declines, even in a major downturn. The homeowners’ large equity reserves permit them not to have to sell their property.
Additionally, class-A properties are still the most appealing to tenants and generally require fewer capital improvements to compete for leases as economic recovery gets underway.
Willing to be working on it
The willingness of non-bank lending institutions to conduct workouts on loans also assisted in reducing the delinquencies of their office loans and avoiding bankruptcy losses. An additional Johnson’s report stated, “Forbearance and loan modification seem to be the most common practice for COVID-19-related difficult loans across the CRE sector… This has led to lower rates of delinquency, since the majority of borrowers aren’t in debt on mortgage payments as per the terms of their modified loans.”
The expected increase in foreclosures and debt sales didn’t occur, according to CBRE’s Marvis. No one sold out an entire loan book. “The pandemic was no one’s fault, and banks restructured loans,” Marvis writes and adds that some lenders increased their interest rates to cover losses, and some were able to recapitalize loans.