A record-setting 243 million square feet of U.S. office space is set to expire in 2022, The Wall Street Journal reports. The total is the largest amount of office space to become available in one year since real estate services firm JLL started to monitor the data in 2015. The jump in office lease expirations has put commercial real estate owners in a tough spot while banks and other lenders could be left with additional troubled loans.
COVID-19 pandemic’s role in office space lease expirations
The increase in upcoming available office space has been tied to the COVID-19 pandemic. Initially, many CRE owners didn’t feel the impact because tenants were locked into long-term leases. Rent was paid even as corporate tenants worked remotely. As those leases expire however, tenants don’t require as much office space because they’ve moved to a hybrid work model, according to brokers.
“I don’t think the landlords have felt the pain yet,” Jeffrey Peck, vice chairman at commercial real-estate brokerage Savills, told The Wall Street Journal. “Now they’re going to start feeling the pain.”
These upcoming lease expirations represent a 40% increase since 2018. The jump has left office landlords even more frustrated as they’ve already been trying to navigate the slow return to office numbers and a 12.2 percent national vacancy level — up from 9.6 percent at the end of 2019, per real estate data firm CoStar Group Inc.
Unfortunately, the demand for office space could continue to drop, according to real estate analytics firm Green Street. The rise of hybrid work could lead to office space demand falling 15%. When leasing revenue falls, so do profits and building value since many building expenses are fixed.
Troubled loans on the rise
Special servicers handled almost 21 percent of the office loans made after the global financial crisis packaged into commercial mortgage securities in February, The Wall Street Journal reports. Loans within that 21 percent that special servicers did not handle were on watch lists. Loans in either category could lead to defaults, according to a Barclays report.
Meanwhile, Esther George, president of the Federal Reserve Bank of Kansas City, recently expressed concern about the threat remote work poses and increased interest rates, both of which could hinder office landlords and their lenders.
“Community banks in particular can have concentrations in this area,” George said at an Economic Club of New York event. “We do see the structural changes that are taking place right now.”
Most lenders have not felt significant pain from their office loans — yet. That could change if any of these industry shifts begin to devalue their properties.
“We’re watching closely,” said Chris McGratty, head of bank research for KBW.
Outlook for office space in the near future
On a more positive note, big tech companies have expanded their office space by more than 12 million square feet since the pandemic hit, according to JLL. Lenders are also being more cautious, avoiding “superhigh” leverage levels that offer minimal support in the event of a property losing value.
Still, the combination of increasing interest rates, higher vacancies and significant debt coming due, could be a “triple whammy” for office CRE owners, Matthew Anderson, a Trepp managing director, told The Wall Street Journal.
Data shows that office tenants don’t plan to lease more space in the near future. Office touring numbers have dropped by half from where they were pre-pandemic, according to real estate data firm VTS. Meanwhile, companies looking to lease space want to do so on short-term deals.
For example, law firm Herrick Feinstein LLP wants to decrease its office space by 30% to 40% when its lease expires in a few years, according to Jonathan Adelsberg, co-chair of the firm’s real estate department.
“You can have a bigger office or a bigger home,” Adelsberg said. “I mean, what would you prefer?”