Whatever their CEOs say, banks are wary of the office


speak as if office will soon look more or less like it was before. Their mortgage teams seem less secure.

Banks on both sides of the Atlantic are increasingly selective about which offices to lend against. Pockets of the market held up during the pandemic: Banks’ rate for mortgages on the best offices in central London was 1.65% in the first quarter of 2021, roughly where it was before the crisis, data of the real estate company CBRE spectacles. But UK lines of credit for older, less central offices are near all-time highs, the Cass Business School Commercial Home Lending Report shows.

In the United States, the value of new office loans issued by banks in the first quarter of this year was only 35% of levels in the same period of 2019, according to data from Trepp, a steeper decline than for unloved retail assets such as shopping centers. The spread between office mortgage rates and 10-year Treasury bills has also widened from pre-crisis levels.

The value of new office loans issued by banks in the first quarter was only 35% of the levels of the same period of 2019.



Photo:

Amir Hamja / Bloomberg News

The increase in the cost of debt is notable because the default rates on existing office loans are currently below 1%. Renter businesses stuck in leases continue to pay rent, so landlords have honored their mortgage payments. But that could change once existing contracts end and white-collar workers spend more time at home. Companies ranging from the tech giant

Facebook

at the world bank

HSBC

plan to let some staff work remotely on a permanent basis.

Oversupply is already a problem in San Francisco, leading to sharp declines in rents and high vacancy rates. Lenders are also watching New York closely. In the Mid-Atlantic region, which includes the struggling Manhattan market, nearly a third of outstanding bank loans now fall into the riskier “critical” category, up from 6% before the pandemic, data shows. survey collected by Trepp.

The pandemic has also accelerated the pre-Covid trend towards more energy efficient offices with solid common spaces, good ventilation and natural light. Costly improvements are needed both to keep workers coming back and to meet growing business expectations for disclosure and reducing their carbon footprint. Unfortunately for landlords, green credentials seem to be becoming a rental requirement rather than the basis for charging tenants a premium.

All of these factors make it difficult to predict where office valuations are heading and therefore take out loans. In central London, the best offices are still changing hands with high valuations yielding rental yields of just 4%, supported by low interest rates and strong demand from overseas buyers. Shareholders are more bearish. The discount to book value that UK and US office real estate investment firms now trade involves a 15% and 10% drop in the value of the properties they own, respectively, according to property research firm Green Street.

For now, mortgage borrowers are also erring on the side of caution. Seen through the prism of their lending activity, banks’ efforts to expand staff offices appear timid.

Plexiglass dividers and floor decals may not be permanent, but the pandemic will bring lasting change to offices. Experts from the architecture and real estate industries explain how they get back to work and what offices will look like in the future. Photo: Cesare Salerno for The Wall Street Journal

Write to Carol Ryan at [email protected] and Rochelle Toplensky at [email protected]

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