Post-Covid World: Commercial Real Estate Investors Grapple with Unprecedented Losses

In the wake of the Covid-19 pandemic, commercial real estate investors are bracing themselves for significant losses. Experts warn that struggling property owners should consider selling their properties now, as the shift towards telework becomes a stable policy in the post-pandemic era. The question on everyone's mind is this: if people continue to forgo malls and office spaces in favor of remote work, how safe will these buildings be?

For seasoned commercial real estate investors, rising interest rates, persistent inflation, and tough economic conditions are nothing new. They have weathered these storms in the past, waiting for rental demand to increase and borrowing costs to fall. Typically, cyclical downturns in demand do not drive them to sell off their office buildings and shopping malls, as long as lenders remain confident in their ability to repay the loans and the property values remain higher than the loan amounts.

However, the landscape is changing rapidly. With telework becoming the policy of choice for many companies and consumers increasingly turning to online shopping, cities like London, Los Angeles, and New York find themselves flooded with buildings that are either unwanted or no longer necessary. Consequently, the recovery of skyscrapers and sprawling malls in city centers could be significantly delayed. If tenants are not found quickly, owners and lenders face a higher risk of financial loss compared to previous cycles.

According to Moody's, global banks hold approximately $3 trillion in commercial real estate loans, with most of them maturing between 2023 and 2026. US banks have already witnessed a spike in real estate loan losses in the first half of this year and anticipate further losses. These banks also state that loans provided to US office and industrial real estate investment trusts (REITs) are now 17.9% more likely to default compared to just six months ago. Likewise, borrowers in the investment and property development sector in the UK face a 4% higher default risk.

Despite these vulnerabilities, some global policymakers remain hopeful that the shift in work habits post-pandemic will not lead to a credit crisis like that of 2008-2009. However, demand for loans from companies in the euro area has hit a record low, signaling a decrease in confidence. In the US, banks are expected to experience a lower loan loss rate in 2023 than in 2022, even in the extreme version of the Fed's annual stress tests that assumes a 40% decline in commercial real estate values. Meanwhile, the average commercial property value in the UK has dropped by about 20% from its peak, but banks have not suffered significant loan losses due to reduced exposure to the real estate sector compared to 15 years ago.

This changing landscape has already claimed casualties. Earlier this year, Credit Suisse in Switzerland and Silicon Valley Bank in the US collapsed due to the impact of interest rates. Additionally, office occupancy worldwide declined by 18% year-on-year in the first quarter, as reported by global real estate agency Jones Lang LaSalle (JLL). High-end office rentals in major cities like New York, Beijing, San Francisco, Tokyo, and Washington D.C. even reached negative growth during the same period. Office vacancy rates in Shanghai, China's financial hub, increased 1.2 percentage points year-on-year to 16% in the second quarter, highlighting the struggles faced by businesses.

Furthermore, companies are under increasing pressure to reduce their carbon footprints. HSBC and other businesses are downsizing and terminating leases for offices deemed insufficiently environmentally friendly. JLL estimates that more than 1 billion square meters of office space globally will require renovations by 2050 to meet net-zero emissions targets.

Investors are taking note of these challenges and adjusting their strategies accordingly. Australia's largest pension fund, AustralianSuper, has halted new investments in unlisted retail and office properties due to poor returns. Short-sellers are also targeting real estate companies listed worldwide as they anticipate a decline in share prices.

Considering all of these dynamics, it is evident that the future of commercial real estate investments is uncertain. As an investor or property owner, it is crucial to assess the risks and make informed decisions about timing and market conditions. The key lies in closely monitoring developing trends, understanding the potential impact of telework on property values, and staying attuned to both local and global economic conditions.

The landscape for commercial real estate investors has dramatically shifted in the post-Covid world. With the rise of telework and online shopping, property values in city centers are struggling to recover, leaving owners and lenders at a higher risk of financial loss. Global banks are already grappling with the potential default risks associated with commercial real estate loans. However, despite the challenges, there is still hope that the shift in work habits will not lead to another credit crisis. Investors and property owners must remain vigilant, adapt their strategies, and closely monitor market conditions to navigate through these uncertain times.