Office landlords squeezed by falling occupancy rates, refinancing difficulties. Here's why

By AP News

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The failure of several large lenders earlier this year and the banking turmoil that followed have fueled worries for owners of office space

Off the Charts Commercial Real Estate

LOS ANGELES (AP) — The failure of several large lenders earlier this year and the banking turmoil that followed have fueled worries for owners of office space such as Boston Properties and Vornado Realty Trust.

The sharp runup in interest rates by the Federal Reserve over the past year and a slowing economy had already set the stage for office building owners and other commercial real estate companies to have a harder time refinance their debt. Then the bank failures, starting with the mid-March collapse of Silicon Valley Bank, rattled the banking industry, which has since tightened its lending standards.

Unlike apartments, industrial buildings and other commercial property sectors, office space has been plagued by rising vacancies since the pandemic popularized working from home.

Falling demand for office space could lead to declining property values, which also makes it harder for owners to refinance. That could drive up loan losses for banks and further limit lending in healthier areas of the commercial real estate market.

“That’s one of the fears or risks here, that if office really gets hit so hard, it can end up bleeding its way into the other sectors,” said Thomas LaSalvia, director of economic research at Moody’s Analytics.

In the first quarter, the vacancy rate for office properties across the nation's 50 biggest metropolitan areas was 19.1%, the highest rate since 1991, according to Moody's Analytics.

It’s common for commercial real estate owners to refinance loans on their properties every few years, as it helps free up cash to make improvements or expand their portfolio. As the value of a commercial property increases, usually via strong occupancy rates and rising rents that generate income for the owner, the terms they’ll get to refinance the loan on the property tend to become more favorable.

However, the reverse is also true. For example, as vacancies rise, less rental income comes in, and that could make the property a riskier bet for a lender, who could then charge more to refinance or even refuse to do so altogether.

Almost $1.4 trillion of commercial mortgages are set to mature over the next two years, according to Moody's. Among office properties, roughly $1.2 billion in loans were scheduled to mature between January and April, but 61%, or $701.3 million, went unpaid, the firm said. Another $7.8 billion in loans are set to be paid off by the end of the year.

Investors have sought shelter from the office space woes this year. The office property segment of the FTSE Nareit Equity REITs Index, which includes virtually all REITs, is down roughly 24% this year. Boston Properties has fallen 28.5% and Vornado is down 35.8%. Meanwhile the benchmark S&P 500 index is up about 7%.

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