As companies make a push to bring workers back into the office, office buildings stuck in the 80s are going to face a reckoning, a new report from Moody’s says.
Businesses are working hard to lure people back into the office after three years of remote work.
But a reluctance for people to fully embrace the return to work is prompting many companies to give employees the flexibility to work from anywhere, from Airbnb to Zillow.
That spells trouble for commercial real estate, specifically office buildings, as tenants fall out. Coupled with debts coming due in the near-term and a possible credit squeeze, the sector looks like it’s in for a crash landing.
Particularly older office spaces built in the 1980s and before, which don’t offer the same level of amenities and features that employees may like, Moody’s said in a new report, the writing may be on the wall.
Properties built before the 1980s are at greater risk of becoming functionally obsolete “because generally speaking, if there were no significant renovations to the building, the amount of capital required to bring it ‘current’ and compete in today’s market would be costlier,” Nick Villa, an economist with Moody’s Analytics, told MarketWatch.
For instance, consider the cost of replacing an outdated heating, ventilation and air conditioning system to meet modern standards, he added.
Commercial real estate facing a cliff
There is $5.6 trillion outstanding in commercial real estate mortgages, according to the Mortgage Bankers Association.
Out of that pile, when looking only at specific real-estate assets like apartments, office, retail and industrial, the outstanding balance goes down to $4.4 trillion, with the remained tied to construction projects, development loans, farmland and the like. And 40% of this amount is held by institutions that are insured by the FDIC.
At the same time, around 16% of the $4.4 trillion in outstanding commercial real estate mortgages are set to mature in 2023, Moody’s said, a quarter of which are backed by office properties.
These loans are vulnerable because they need to be refinanced. They had been originated around a decade ago, when rates were lower. Refinancing now means that their new rate will be far higher. And if interest costs rise, borrowers will have to add equity to refinance or raise rent levels so that they can continue servicing the debt at adequate levels.
At the same time, banks are becoming more sensitive to who they lend to, hence tightening their lending standards, amid the crisis in banking.
An attempt to bring remote employees back
Some employers are vacating old spaces and turning to shiny new properties that may be more enticing to employees reluctant to return to the office.
A third of workers with jobs that can be done remotely are working from home all the time, according to a report from Pew Research Center.
Among those employees who have a hybrid schedule, meaning they work some days from the office and the rest from home. Out of this group, 63% said their employer requires them to come in person to work for a certain number of days per week or month.
Employers are abandoning old spaces built in the 1980s as they “seek to encourage workers back to the office with more modern amenities and design layouts,” Moody’s said.
“The vast majority of professional services firms are gravitating toward 2-3 days in office in a partial remote work arrangement,” Kevin Fagan, head of commercial real estate analysis at Moody’s, said.
Employers are trying to make meetings more focused, he added, by trying to make their office spaces present more opportunities for people to meet and collaborate, with the ability to connect with remote employees.
“This isn’t always a way to lure employees back, as much as a way to make their limited time in the office more effective,” Fagan said.
But others are scaling back on how much space they’re renting, in preparation for a looming recession, like Twitter and Liberty Mutual.
The worst-placed assets in commercial real estate are old office spaces, Moody’s said.
“During this ongoing evolution, an economic slowdown could leave metros with a high stock of pre-1980 … properties vulnerable,” Moody’s stated.
Roughly 31% of office buildings in the top 80 metro areas in the U.S. were built before 1980. And these are “particularly susceptible to an economic slowdown,” Moody’s said.
Metros with the highest concentration of old offices
Who’s got the most office space dating back to the 80s?
Wichita, Kans. has the highest percentage of pre-1980s office stock, Moody’s said. The company calculated total square feet, not building count.
That’s followed by Syracuse, N.Y., Oklahoma City, Okla., Rochester, N.Y., and New York City.
“Almost two-thirds of the NY Metro’s office buildings were built before the 1970s,” Villa said. “Given the city’s extensive history, perhaps it’s not surprising that the majority of its office buildings tend to be relatively older compared to other metros.”
At the other end of the spectrum, Las Vegas, Nev. had the lowest percentage of pre-1980s office stock. Other cities with a high share of newer office stock include Austin, Tex., suburban Virginia, Ventura County in Southern California, and the Raleigh-Durham area in North Carolina.
But the young age of the office stock doesn’t necessarily mean that Vegas or Austin are immune to experiencing distress during a downturn, Moody’s said.
Austin’s heavy concentration of tech companies could add to the “cyclical volatility of its economy,” Moody’s said. The tech sector’s seen many layoffs over the past few months.
And the rankings were not adjusted for renovations, Villa added.
This post was originally published on Market Watch
