October 4, 2022

Remote work that started as a temporary solution at the onset of the Covid-19 pandemic has made one of commercial real estate’s most prolific sectors the biggest question mark more than two years later.
In a recent white paper, the Mortgage Bankers Association examined two potential outcomes for the U.S. office market, based on whether current trends in hybrid work permanently stick — and people continue to go into the office less frequently. The second scenario imagines what could happen if a looser labor market means employees will be prompted to go into the office more often, seeking job security.
In the “base case” scenario of widespread hybrid work, companies would require around 80% of office space they previously needed, and income and values could drop 10% to 20% — although that’s heavily dependent on location, the MBA notes. The flight-to-quality trend observed especially in the wake of the pandemic would become more apparent in this scenario, with older, outdated space likely seeing significant discounts while Class A-rated space (or higher) seeing significant premiums.
In an alternative case scenario, with most employees in the office at least three days a week, office spaces would remain similarly sized as pre-pandemic, and incomes and values wouldn’t be as severely affected beyond an initial period of volatility. Office space would price similarly by class as it did pre-pandemic.
Jamie Woodwell, vice president of research and economics at the MBA, said the reality will likely fall somewhere in between, and individual company decisions make it difficult to assess what will happen.
But already there’s been an observable slowdown in originations for office property since pre-pandemic days as those questions linger.
In 2019, bankers originated $113 billion of mortgages backed by office properties, the MBA found. That fell to $95 billion in 2021. The commercial mortgage-based securities market was responsible for about $51 billion of office loans in 2021, and life-insurance companies for roughly $15 billion, with banks and investor-driven lenders making up the majority of the rest, according to the MBA.
While the first half of 2021 saw record commercial mortgage volume in terms of originations, much of that was concentrated in property types that’ve gone gangbusters since the pandemic, the MBA found — namely, multifamily and industrial. There was also an observable bounce-back in hotel and retail, sectors that struggled during the earliest part of the pandemic.
Commercial and multifamily mortgage loan originations were up 72% in the first quarter of 2022, compared to the same period in 2021, while those categories of originations were up 19% in Q2 2022 over Q2 2021.
And while originations for office were up 4% in the first half of 2022 compared to the same time a year prior, the first six months of 2021 were very subdued, Woodwell said.
“There (are) a number of indicators to say investors and lenders are still working through the uncertainty of the office sector and the ways changes in use of office may or may not affect those properties going forward,” he continued.
The MBA’s white paper used, as somewhat of a case study, the fallout on the U.S. office market following the 2001 dot-com bust, finding net operating incomes for office properties fell 12% between Q2 2000 and Q4 2004. The Federal Reserve Board of San Francisco in an October 2001 report found San Francisco’s vacancy rate rose sharply very quickly, from 1.7% in Q1 2000 to 10.3% in Q2 2001.
Woodwell said while the early 2000s recession can be used somewhat as a benchmark, there are key differences between that office-market slowdown and what’s currently being seen.
For one, a lot of companies in places like San Francisco went bankrupt and, therefore, had to quickly exit their leases.
“It’s really remarkable how little that has been the case in the past few years, despite what you saw in terms of retail and hotel property incomes,” Woodwell continued. “At office properties, even when they were generally fully vacant during the worst of the pandemic, the companies leasing that space still were paying those leases, and have continued to.”
Despite the recent disruption for office, there isn’t expected to be a sudden downturn in key metrics, such as vacancy, as was observed in 2001 and ensuing years. But if hybrid work remains a permanent fixture for the majority of office-space using companies, similar declines may be observed over the course of a decade.
In fact, the office delinquency rate remains low. It stood at 1.52% as of Aug. 31, according to Radnor, Pennsylvania-based commercial real estate data firm CRED iQ. Those who track the CMBS market previously told The Business Journals any uptick in office delinquency is likely to be episodic, rather than a tsunami.
That doesn’t mean serious declines in vacancy — and valuation — won’t be seen within the national office market, but it’ll likely take more time for that to become apparent. Leases would expire over the next decade, and impacts would different across geographies.
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