Delayed Impact: How COVID-19 Is Starting To Hammer Office Properties

Delayed COVID Impact

With corporate tenants typically locked into long-term leases, many office building owners have not lost money since the outbreak of COVID-19, even with so many employees working from home. But the growing trend of remote work is beginning to bear itself out in the numbers, as a record amount of office space is hitting the US market this year.

Real-estate services firm JLL (JLL) reported leases expiring this year account for 11% of the nation’s office space. With vacancies starting to pile up at this stage of the pandemic, both property owners and their lenders have come under pressure. Many companies are deciding to shrink their offices as the hybrid work model grows in popularity. Some who signed leases over the past several years have opted for short-term agreements, rather than the industry standard of 10 years or more.

Could Get Worse

Some analysts feel the trend could worsen for the office sector, as property owners have been frustrated by a slower-than-expected return-to-work process, combined with a national vacancy level of just over 12%. CoStar Group (CSGP) notes that’s the highest such number since the start of the pandemic, and more than 2.5% higher when compared to this time in 2019.

There are other challenges property owners face, perhaps chiefly the possibility of a broader economic slowdown, which always affects office leasing. Kansas City Fed President Esther George specifically noted the sector faces risks due to remote work and rising interest rates, which will harm not just property owners but also their lenders.

Problem Loans

Analysts explain that office buildings are especially vulnerable to vacancies because most of their expenses are fixed, and profits quickly diminish following even a modest drop in leasing revenue. This leaves property owners increasingly unable to meet their debt obligations, and triggers the rise of so-called troubled loans. Market watchers say the number of office loans considered at risk of default is at its highest level since 2010.

As banks begin reporting first-quarter earnings in the weeks ahead, the impact of troubled loans could become more clear. Financial services firm Stephens Inc. published a report this week noting both Heritage Financial Corp. (HFWA) and Eagle Bancorp (EGBN) have more than 13% of their loan portfolios backed by office buildings. Estimates suggest the hybrid work model will continue to cause a drop in office space demand, and that translates to vacancies.

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