- Workers have a preference for work from home which may become permanent and if it does employers who recognize and adapt to that reality will have an advantage obtaining and retaining talent.
- Office demand may be even weaker than reported due to the high level of space that is currently being subleased by existing tenants and that structural vacancy rates may be as high as 50%.
- The authors discuss how e-commerce up-ended regional malls and the negative feedback looped that ensued; retailers left malls, leading to fewer shopping options, making malls less attractive for shoppers, leading more tenants to leave.
- The preference for work-from-home is much like that of e-commerce and may lead office down it's own negative feedback loop that will need to ultimately culminate in finding a new "highest and best use" (I like the nod to accounting terminology out of ASC 820) for these properties, most likely with significant reduction in current value.
- It is not clear that appraisers have fully baked in the possibility of structural vacancies, instead continuing to focus on in-place leases and some assumption that the future will be like the past and not yet reflecting the risk premium that would be required to actually sell an office to a new owner.
- Because the OFR is focused on financial stability as one its mandates, they highlight 3 risk to financial stability due to declining office values:
- Significant losses for financial institutions holding debt and equity positions tied to office
- $3.2 trillion of total value is current in the office sector and losses of over $180 billion are plausible
- This loss of value would happen over time but would hit direct lenders and exposed CMBS.
- The loss of tax revenue for municipalities
- Commercial property taxes make up a significant portion of municipal revenues and may be difficult to replace which could deteriorate municipal balance sheets.
- The high cost of repurposing the buildings
- Unlike malls, offices don't sit on large land parcels around their buildings, offices tend to be in dense areas and cannot be easily transformed into warehouse or distribution or storage centers.
- There are likely a number of challenges to convert office to multifamily.
- The most likely outcome is to demolish the buildings.
While the brief is certainly not prognosticating that office is doomed, it does outline the risk which are generally known by market participants. The question is exactly what scenario the market is pricing in for office and whether or not it's reflective of the risk posed in this brief.
Omg! This is awesome man keep it up!
ReplyDeleteHow did they lose that much money!? That’s crazy.
ReplyDeleteI am thrilled to share some incredibly thought-provoking insights from the recent report by the Researchers from the Treasury Office of Financial Research. Titled "Work from Home and the Future Consolidation of the U.S. Commercial Real Estate Office Sector: The Decline of Regional Malls May Provide Insight," the report delves into fascinating key points that shed light on the evolving dynamics of the office sector.
ReplyDeleteThe authors astutely point out the growing preference for remote work, which could potentially become a lasting trend. Recognizing and adapting to this shift could indeed give employers a strategic advantage in talent acquisition and retention. Furthermore, the report highlights a potentially significant challenge for the commercial real estate office sector, suggesting that office demand might be even weaker than currently reported due to the substantial amount of subleased space.
Drawing parallels with the impact of e-commerce on regional malls, the report warns of a negative feedback loop that the office sector could experience. This comparison provides a fresh perspective on the potential consequences of the work-from-home preference. The authors suggest that the industry might need to redefine the "highest and best use" of these properties, which could lead to a substantial reduction in their current value.
Equally noteworthy are the financial stability risks outlined in the report. The potential for significant losses for financial institutions, the impact on municipal tax revenue, and the challenges of repurposing office buildings raise crucial concerns that must be addressed. The report compellingly makes the case that the existing market scenario might not fully encompass these risks, warranting a deeper examination of the pricing and risk assessment strategies.
While the report doesn't definitively predict the demise of the office sector, it undeniably provides valuable insights into potential challenges that both investors and market participants should be acutely aware of. The question that lingers is whether the market's current assessment of the office sector's future aligns with the risks unveiled in this enlightening brief.
The intersection of remote work preferences, structural changes in the office sector, and potential financial repercussions creates a dynamic landscape that demands continued analysis and adaptability. The report's thorough exploration encourages us to think critically about the future of the commercial real estate office sector and how we navigate these evolving trends.
Excitedly awaiting further discussions on this transformative topic,