Yahoo Finance Remote-work trend creates mortgage-backed securities default risk, Moody's warns
The popularity of working from home in the U.S. is cutting into office tower revenue to the point that it is putting some commercial mortgage-backed securities at risk of default, according to a new report from the credit rating agency Moody’s.
“Lenders’ anticipation of lower office revenue is creating refinancing difficulty for office loans with low debt yields and loans with significant lease maturities in the next 36 months,” the March 20 report said.
In the past, commercial mortgage backed securities, which draw on the flows from a number of commercial mortgages, have proven beneficial to investors because they generate reliable cash flow at a fixed interest rate and come with prepayment penalties that discourage borrowers from making early payments — ensuring that the cash flow continues throughout the loan period.
However, as companies shed office space, lease rates from commercial real estate are falling, reducing overall cash flow to office towers and potentially weakening the ability of borrowers to pay back their debt.
According to Moody’s, office revenue has already fallen roughly 10 per cent below where it should be given the robust employment levels across the U.S.
“Revenue will remain particularly stressed in markets with (1) a large concentration of industries, such as technology, that have adopted high levels of hybrid work and (2) difficult commutes,” the report said.
Decreased office use has led to record office vacancy rates in some U.S. cities. And based on commercial real estate firm CBRE’s forecast, the increase in vacancies is expected to continue into 2024.
CompStak, an American lease data provider cited in the report, indicates that the average office lease still has 5.1 years remaining on it. In other words, the higher market vacancy rates and lower rents will not be reflected in specific office cash flows for some time.
“Given this tenure, some maturing leases may still see tenants roll to higher rental rates, providing an increase to landlord revenues,” the report added. “Landlords also still receive cash flows on any sublet space available in their buildings. This gradual space rollover is why net operating income (NOI) from CMBS office properties has decreased only 3.7 per cent from its 2020 peak, which is a far narrower change than suggested by the large jump in market vacancies. However, market levels eventually translate into property cash flow.”
Nevertheless, between Q4 2019 and Q4 2022, national vacancy rates increased by five per cent while rents decreased by 2.3 per cent.
Of the 25 largest office markets, San Francisco recorded both the highest increase in vacancy rates at 13.5 per cent and the sharpest drop in asking and taking rents — down 13 per cent and 31 per cent, respectively. San Francisco’s rent taking rate has reportedly fallen back to 2014 levels while Charlotte, N.C. recorded the most significant growth in both asking and taking rents — up 9.5 per cent and six per cent, respectively.
By contrast, Central New Jersey experienced the lowest vacancy increase — up by just 1.2 per cent.
• Email: shcampbell@postmedia.com
