Companies will likely continue to grapple with their future plans for the office long past when a Covid-19 vaccine has been widely distributed. Questions about whether employees will work remotely permanently, whether a hybrid model is best and maintaining corporate culture will dominate these decisions.
As office occupiers work through these questions, office CMBS will likely continue to feel the strain.
According to Trepp, the November delinquency rate for office loans was 2.27%, a drop of 22 basis points from October. Trepp’s Manus Clancy and Joe McBride both believe that this rate will rise through next year, with the increase in work from home orders and the future of office being uncertain globally.
McBride predicts the rate will increase to 4.15% in July of 2021. Manus is a little less skeptical but still expects a slight increase of up to 2.75%.
Trepp is not alone in its assessment of the CMBS market. A report from Morgan Stanley predicts that office CMBS will continue to be plagued by properties that remain empty or under leased after the pandemic is tamed.
“For property types that are really struggling, I’m not sure vaccines are changing that,” Richard Hill, head of commercial real estate research at Morgan Stanley, told Bloomberg. “There will be a wave of forthcoming liquidations as special servicers take steps to resolve distressed loans.”
Morgan Stanley projects that conduit losses could average 5% to 8%, depending on the vintage and that some BBB-rated notes could take losses of around 64%.
The issues plaguing the office sector are readily apparent.
Though office tenants are typically locked under longer-term leases that should continue to allow borrowers to maintain their debt service obligations, many firms with upcoming lease expirations will re-evaluate current remote working models and either downsize or reconfigure, according to Clancy and McBride.
Other firms may decide to vacate altogether, with remote working becoming more of a permanent fixture and its adoption in the corporate work culture extending beyond the scope of the current health crisis.
Ultimately office properties’ problems come down to simple math: As rent revenue declines, expenses relating to making buildings safe and healthy have risen during the pandemic.
A recent survey by Deloitte found that increased costs to implement health and safety standards will lead to increased operational costs of $19.40 per square foot, translating to a 5.8% increase in average annual office rents from the beginning of 2020.
Unfortunately, many landlords might find that a stretch too far. In the Deloitte survey, only 38% of respondents from the US said that their organization could handle both the operational and financial challenges of the pandemic.