Moody’s Analytics Tries to Handicap Office Economic Vulnerability

Last week, Moody’s Analytics pointed out that moderate changes to office cap rates and cash flows could cause big problems. This week, the company digs in more to recognize that a threat for CRE isn’t uniform and the question those in the industry should look at is vulnerability and how much sway concerns with banks could hold.

For example, there is the number that $2.3 trillion in commercial real estate debt is held by “small” banks. First, says Moody’s, look at the entire field of CRE financing. The firm built up and then whittled down the totals, looking at Mortgage Banker Association estimates, and ended with $1.75 trillion of income-producing real estate held by FDIC-insured entities.

If one expands the number of “large” banks beyond the top 25 and add regional banks with more than $10 billion in assets but less than $160 billion, together they would hold almost 70% of CRE loans. But for smaller banks, CRE loans are 13% of total assets, while they are 4% of the largest 25 banks.

Topping this, most maturing CRE loans were made 10 years ago when rates were cheap and leverage, plenty.

“These loans now need to be refinanced at a much higher interest rate,” Moody’s wrote. “Borrowers would need to see rent levels increasing to keep the debt-service-coverage-ratio (DSCR) at adequate levels. Also, cap rates for office properties are increasing and will likely move higher, implying further value declines are expected. Coupled with the fact that banks are tightening their lending policy in response to the recent turmoil, commercial real estate is in a precarious position.”

That is the environment. Now for office. One factor is in 80 primary metros, 31% of office buildings were built before 1980 and so are potentially “obsolete.” But even this is overly general. The metros with the highest percentages of pre-1980 B and C Class office stock are New York City, NY (34.7%); Rochester, NY (34.9%); Oklahoma City, OK (35.2%); Syracuse, NY (35.6%), and Wichita, KS (38.5%).

The ones with the lowest percentages are Las Vegas, NV (4.1%); Austin, TX (6.1%); Suburban Virginia (6.4%); Ventura County, CA (6.7%); and Raleigh-Durham, NC (6.9%).

But then, any analysis of a metro area has to include size due to sheer numbers. Or, as Moody’s pointed out, high concentration of tech businesses and cyclical volatility could increase the vulnerability of an area like Austin. Higher percentages of buildings with better amenities might face issues if the cost in money and time of commuting kept employees away.

“In short, astute property owners and employers are likely to focus on what’s in their control,” Moody’s added. “This includes revitalizing their buildings’ design layouts and incorporating modern amenities and collaborative workspaces to attract workers in such a tight labor market.”

However, it is important to add the rate at which changes happen and complexities of metrics complicate vulnerability assessment.

Moody’s noted that the 2022 Q4 pullback brought GDP down to 2.6% from an earlier estimate of 2.9%. As the firm said, it’s “still a healthy figure.” That was from the US Bureau of Economic Analysis.

The Federal Reserve Bank of Atlanta keeps a running non-official estimate of economic growth. On March 31, 2023, it was 2.5%. By April 3, it was down to 1.7%. This is a fast-moving roller coaster that is far from a fun amusement ride that you can forget about once you’re off.

As for complexity, Moody’s mentioned PCE growth falling to 0.3%. As Nationwide Chief Economist Kathy Bostjancic wrote in an email note last Friday, “Less encouragingly, core services less housing—the super core price measure—rose to 4.4% on a year-on-year basis from 4.3% in January and is only down slightly from the 4.7% peak in November 2021.”

It is difficult for experts in economics and finance to keep up, let along everyone else. Understanding CRE vulnerabilities is likely to be a moving target and one that could require attention and swift action.