Offices brace for bad news
Commercial Reits have tumbled this month over fears of a credit crunch – but the main risks are in the US
After Silicon Valley Bank and Credit Suisse, investors are casting around for the next crisis and commercial real estate (CRE) is number one on the list. US real estate investment trusts (Reits) have tumbled. SL Green, the biggest New York office and shopping-centre Reit, is off by 37% in a month. Vornado, which has similar exposure, is down 27%. Boston Properties, the biggest listed developer nationally, is down 21%.
While the US is the eye of the storm, other markets haven’t been spared. In the UK, British Land, Derwent, Great Portland, Landsec and Shaftesbury are all down by 14%-17%, for example. It’s a similar story or worse in Europe.
The immediate fear is that a credit crunch might roll through the real estate market.
The link here is strongest in the US. Small and mid-sized banks (ie, regional ones – the US has many more banks, relative to its size, than most countries) are major lenders to CRE: they account for 70% of loans to the sector, according to Capital Economics. These are the banks that are experiencing the greatest outflows in deposits. That’s partly due to the demise of Silicon Valley Bank, Signature and Silvergate and the fear of further bank failures, but also because higher rates from money-market funds are proving tough competition for the miserable returns they offer on deposits (the deposit rates at US banks make UK ones look generous).
This ultimately means that banks will have to lend less (because they’ll have fewer deposits to back loans) or charge higher rates (because they have to pay higher rates to hold onto deposits). Either way, conditions are going to get tougher. However, there are other reasons why the US CRE looks precarious. Vacancy rates for offices have soared: in San Francisco, rates have hit almost 30%, according to CBRE: pre-pandemic they were at 4%. This varies greatly between markets: San Francisco is in a class of its own due in part to the bursting of the tech bubble, while Boston is at 12.5%, up from 6.5%. It also depends on quality: Class-A offices are holding up better in most places than lower-grade buildings, although in some places, such as San Francisco, even Class A is under a bit of pressure. In short, there’s a glut of older, lesser properties that will need to be worked out over many years.
Notwithstanding all this, I have added a bit to my existing holdings in Alexandria Real Estate (which focuses on life sciences, where demand looks robust) and Boston Properties (whose 7.4% yield is pricing in a fair amount considering its regional diversification and the quality of its portfolio). Still, as regular readers know, I favour Reits as a protection against sustained inflation – and that requires enough demand to raise rents. From this perspective, UK Reits such as Landsec – which last week reported solid demand for prime space – look more compelling right now.