Constant dollars

Someone has to pay the bill for the empty offices

IN RECENT WEEKS diversity at work has taken on new meaning. As vaccination progresses in the wealthy world and restrictions ease, some huge office tenants, like Goldman Sachs, a bank, want staff to return full-time, while others, like rival Citigroup. , expect some employees to never set foot in a central business district again. Behind the posture, a consensus is slowly emerging that white-collar office warriors should be allowed to stay home more often after covid-19 – and that many likely will. Office owners, however, and those who fund them, continue to pretend no storm is coming. With billions of dollars swallowed up in unwanted buildings, they face a brink.

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Office bulls rest their business on two pillars. The first is to argue that recent evidence shows that the disruptions induced by a pandemic are superficial and temporary. The offices have been spared the carnage that the closures have inflicted on other types of commercial property, such as restaurants and stores. Even though rent collection fell elsewhere, most tenant businesses continued to pay on time. Bad debts remain a rarity, and the prices paid for floor space in global cities have held up. Never mind that most open spaces remain eerily silent. Developers are reporting an increase in visits and rentals, and investors have already pledged billions of dollars for new projects.

The other bulls argument involves heroic predictions about the future of work. Workers have missed the water fountains so much, they say, that most will return. Couch fans may be convinced to return to the office with new rooftop pools, pet-friendly concierges and Michelin-starred canteens. Even though some skip a few days a week, the need to space offices in an age of pandemics and the growing appetite for brainstorming mods after a year of dismal Zoom calls should keep the demand for office space constant. . And even if it doesn’t, unwanted space can still be reclaimed, for example by turning it into chic industrial lofts or logistics centers.

Such optimism is illusory at best, dishonest at worst. It’s too early to tell if offices have avoided the pain months of social distancing have caused in other industries. Government aid, lenient banks, and largesse from central banks may have delayed defaults and troubled sales. Business tenants are stuck in long-term leases that have not yet expired and may not be renewed. Transaction prices are a poor indicator of the health of the market: because buyers and sellers cannot agree on terms, there have been few sales. In some countries, new variants of covid-19 may result in restrictions, delaying a full reopening.

Even small declines in long-term occupancy rates will have a big effect on rents and prices. the IMF estimates that an increase in vacancy rates of five percentage points in all commercial properties would result in a drop in valuations of 15% over five years. Fitch, a rating agency, says if American workers don’t commute at least three days a week, ratings could drop by more than half.

Since rival Moody’s predicts that one-fifth of the country’s offices will be empty by 2022, owners may have to prepare for the worst. The uncertainty is compounded by the indecision of many businesses. Many have yet to make up their minds on hybrid work, which could yet become a new standard.

Abstract debates over aggregate demand mask the fact that property issues will not be equitably shared. As companies seek to attract talent and foster teamwork by reorganizing their HQs, chic offices in city centers will remain in demand (although making them chicer, healthier and greener will cost homeowners dearly).

However, they are outnumbered by old and poorly ventilated buildings which will have difficulty attracting staff and therefore tenants. Upgrading or converting them will often cost a fortune. At best, their owners face falling rents or discounted sales. At worst, they risk having capital tied up in stranded assets.

Cheaper office rents will help some businesses. But the financial costs are immediate. Banks have loaned $ 2.4 billion to commercial properties in America alone. But they have driven loan-to-value ratios down to the dizzying heights of the financial crisis. A market correction would likely slap them without knocking them out. Instead, more of the bill will fall on stockholders, including pension funds and insurers who, in their quest for returns in an era of low interest rates, are picking up the slack. real estate for years. The sooner they admit losses happen, the sooner they can try to limit the damage.

This article appeared in the Leaders section of the print edition under the title “House of Pain”

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