In this article, you’ll explore:
- The $2.75 trillion in commercial mortgages maturing by 2027 and the $528.7 billion maturing this year.
- Declining office values and rising interest rates impacting tenant decisions and space reduction.
- 217 million square feet of office space facing upcoming lease expirations.
The combination of maturing mortgages, declining REIT values, and the changing landscape of office tenancy poses substantial hurdles for the industry. Navigating these challenges will require strategic planning, innovative solutions, and a proactive response from stakeholders in the commercial real estate market.
2024 will mark a turning point as we face a multi-billion-dollar wall of maturities. But it forces the question: Can we only go up from here? Or, have we only seen the beginning of the full distress?
Fast forward to the full discussion on everything tenants need to know about navigating a post-apocalyptic office market. Receive exclusive first access to "Surviving the Office Apocalypse," for an in-depth look at how tenants can survive the changes coming for the office market.
Wall of Commercial Maturities
It’s no secret that the commercial mortgage sector has been in trouble. With the full implications of a post-Office Apocalyptic market still yet to be realized, a staggering $2.75 trillion worth of commercial mortgages are set to mature by 2027.
Professionals are bracing themselves to be slammed by the upcoming brick wall of maturities. But it’s not like this is necessarily a new challenge. This year alone, an estimated $528.7 billion of commercial mortgages are maturing, with projections indicating a further increase to $532.8 billion next year, according to data from Trepp.
The value of office spaces has dropped by at least 40% since the pandemic, and interest rates have doubled. About 30% of loans are tied to commercial real estate, posing a serious risk amid rising delinquencies. Banks are still supporting these properties, even as their values decline.
And with more pre-pandemic leases coming due, things are not slated to get much better.
The Continued Effects of Right-sizing
Most in the CRE world are not hopeful of what this next wave of lease expirations will bring.
Let’s just say landlords don’t have their fingers crossed in anticipation that their tenants will renew according to the same terms and square footage; many are in talks with their lender about giving back the keys to the properties.
Businesses are widely reevaluating their office space needs, largely leading to a reduction in square footage or even the decision not to renew leases at all. For many, it doesn’t make as much sense to retain the same bulky footprint in a hybrid-friendly working world.
Not to mention that corporate tenants don’t live under a rock. Everyone in the CRE world is aware of the rapid devaluation of office space.
“Market-rate” property valuations likely look a lot different than they were if a lease was signed 5 or 10 years ago. If tenants do want to renew, they can likely do so at a heavily discounted rate. For many businesses, this is a once-in-an-era opportunity to slash CRE costs.
This shift in tenant behavior is amplifying the strain on the commercial office market, specifically on property owners.
Over the next five years, about 500 million square feet of net rentable area (NRA) in office and mixed-use properties, backed by CMBS loans, is on the verge of expiration. In 2024 alone, 112 million square feet of office space are due to expire, and an additional 105 million square feet are set to expire in 2025. This adds up to a substantial near-term rollover risk of 217 million square feet.
These impending expirations are compounded by a concerning trend of rising vacancy rates. In certain markets, vacancy rates are exceeding 20 percent and, in some instances, even reaching a staggering 30 percent. These elevated vacancy rates underscore a substantial risk that many tenants may either downsize their space requirements or, in more severe cases, opt not to renew their leases altogether.
Measuring Commercial Distress
A cycle like this can’t continue for much longer. And unfortunately, with the upcoming distress heading for the market, it may reach its breaking point.
Distressed properties face financial or operational challenges, often resulting in a heightened risk of default or decreased value. And to understand just how bad the levels are getting, the MSCI's US distress tracker report quantifies it.
And the end of this past year was a doozy. In the fourth quarter of 2023, a total distress value of nearly $85.8 billion was recorded.
The breakdown of distress across various sectors reveals significant challenges among the property types.
However, the full picture of distress is yet to be seen because many loans are being privately modified. The real number is perhaps too scary for many in the CRE world to say out loud, and that is almost a quarter of a trillion dollars worth of CRE assets may be troubled.
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“Potential distress indicates that an asset’s current financial position has eroded and that it may become financial troubled. As of December, the value of assets classified as potentially troubled stood at $234.6b, or nearly three times that of distressed assets.“ -MSCI’s US distress tracker |
Geographic Challenges
While this is a national issue, the crisis level does vary by geography… And right now, Manhattan is shaping up to be the hotspot.
Because not only does the New York region boast the highest gross space in the country, but it also faces the challenge of the highest volume of leases scheduled to expire.
By 2028, a staggering 173 million square feet of leases in the New York region are set to expire. 32 million square feet are scheduled to expire throughout this year and 2025, according to the Commercial Observer.
However, it’s not alone in its suffering. Metros are being hit harder across the board. Other honorable mentions following New York in terms of distress and expirations in the next two years are:
- Los Angeles, 15 million square feet expiring.
- Chicago, 12 million square feet expiring.
- Philadelphia, 9 million square feet expiring.
- San Francisco, 8 million square feet expiring.
So just in these 5 metropolitan areas, the total risk of lease rollover is 76 million square feet.
Property devaluation with the threat of more vacant space spells big trouble for these areas. Many cities who rely on the property taxes of their commercial real estate to fund infrastructure and essential services simply won’t have the same funds.
Take New York, which historically relies on the office sector to be responsible for 21% of the property taxes. With properties being sold for a fraction of their previous values, and in some cases, buildings struggle to find buyers at all, is, in turn, has the potential to significantly reduce municipalities' property tax revenues.
Of course, this triggers an urban doom loop where the quality of life drops as the property value does.
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“Sales of financially distressed properties can…lead to a broader downward valuation spiral and even reduce municipalities’ property tax revenues,” the Financial Stability Oversight Council, a federal government organization created after the 2008-09 financial crisis to monitor risks to the financial system. |
The implications are profound, extending beyond the real estate market to impact the financial health of entire municipalities. The doom loop underscores the urgent need for strategic interventions to stabilize property values.
Have We Seen the Worst?
Things don’t look great. However, other see the end of the suffering insight. For instance, Blackstone’s CEO Stephen Schwarzman has come forward explaining that we may have already hit rock bottom and the only way to go from here is up.
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“Blackstone's CEO Stephen Schwarzman views 2023 as a pivotal year, marking a cyclical bottom. This comes even as their real estate segment, typically a star performer, faced continuous underperformance in recent quarters.” CRE Daily |
Others acknowledge the challenges of the last few years but remain optimistic. Much of this hope relies on the expectation that the FED will deliver interest rate cuts. This could set into motion a comeback for the REIT market.
In the meantime, as the situation continues to unfold, tenants have a unique chance to capitalize on the changing dynamics of the commercial real estate market. The widespread trend of right-sizing, evident among tenants globally, provides an opening for businesses to optimize their space utilization.
Even if the traditional office remains integral to your business model, now is the opportune moment to take cues from industry practices and reevaluate your spatial needs. By doing so, tenants can proactively align their real estate strategies with the evolving expectations of the workforce and the broader market. Seizing this opportunity to optimize and adapt can not only enhance operational efficiency but also position businesses to thrive in the post-pandemic landscape.
Don't fall behind on any information that can give your tenancy a competitive edge. For a more thorough assessment on the truth of the office market, you won't want to miss "Surviving the Office Apocalypse." This handbook is the essential survival guide for corporate tenants of today.
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