How likely is it that thousands of empty offices will spark a financial crisis?

in the middle ManhattanThe difficulties faced by the commercial real estate sector are everywhere. On the West Side, near Carnegie Hall, is 1740 Broadway, a 26-story building that investment firm Blackstone bought for $605 million in 2014, but defaulted on its mortgage in 2022. Above Grand Central Terminal stands the iconic Helmsley Building. . Your mortgage has recently been sent into “special servicing” (it may be restructured or your landlord may simply stop paying). As the sun sets, the fundamental problem becomes clear: working from home means fewer tenants. The bright floors, where workers walk around, are interspersed with black lines.

It's not new. Many buildings remain Empty Since the arrival of Covid-19. Initially, business owners waited out the pandemic, but workers were slow to return, so business owners ended up cutting back on staff. Vacancy rates, especially in the most dilapidated buildings, have risen dramatically. Then interest rates rose. Most commercial buildings are financed with five- or ten-year loans. Many of these loans will soon be refinanced, while interest rates remain painfully high. About $1 billion in loans to U.S. businesses will be refinanced over the next two years, representing a fifth of total commercial building debt.

Recently, several large office buildings in the city were listed for less than half their pre-pandemic price. This type of loss will wipe out the assets of many owners, forcing banks to bear significant losses. In fact, three entities have already been significantly affected. In recent weeks, New York Community Bank (NYCB), a mid-sized lender; Ozora Bank, a Japanese institution that stored American loans for commercial real estate purchases; Deutsche Pfandbrief, a German desk-trading group, reported bad news on its loan books, sending its shares down.

at the same time, Chinese real estate crisisAnd it sharpens. As domestic portfolios suffer, some Chinese investors, who have bought properties around the world, may need cash and could start disposing of overseas assets, causing property values ​​to decline. If consumers start to suffer due to higher interest rates on car loans or credit cards, more institutions could end up in a situation similar to NYCB's. It's no surprise, then, that people are starting to fear that the shift to working from home will spell financial disaster.

However, it is useful to put these problems in context. To begin with, the problems facing the New York central bank appear to be institution-specific. Although the bank has exposure to New York offices, it has in fact reduced the value of its loan portfolio on rent-stabilized “multifamily” residential complexes in the city. Their value fell after 2019 legislation restricted landlords' ability to raise rents if the apartment was vacated or the landlord made capital improvements. Another lender that specialized in these types of loans was Signature Bank, which went bankrupt last year (and subsequently had some of its assets purchased by the New York Mercantile Bank).

Moreover, there are limits to how much of a problem offices can be, even if the damage they sustain is significant. The total value of US real estate (not including farmland) reached $66 trillion at the end of 2022, according to data from Savills, the real estate agency. Most of them are residential. Only a quarter of it is commercial. Commercial real estate is much more than just offices. They include commercial buildings in crisis, but also warehouses in high demand such as data centers, distribution points, and multifamily buildings. Thus, the value of offices may reach $4 trillion, or about 6% of the total value of real estate in the United States.

Between 2007 and 2009, US residential real estate lost a third of its value. A similar crisis today would wipe out $16 trillion in real estate values. Even if every office building in the United States lost all its value in one way or another, the losses would still not exceed a quarter of that size. In addition, lenders are better protected against losses in commercial real estate than they are in the residential sector. While loans for commercial real estate often approach 100% of the home's value, even the most ambitious loans for commercial real estate tend to cover only 75% of the building's value.

The wound that commercial real estate inflicts on the financial system is like that of the slip of a kitchen knife: it is disturbing, it is obvious, and it is painful. May require stitches. But it is unlikely to seriously injure the victim.

The injury won't go unnoticed either. Because real estate problems are so obvious, regulators take control of them. Nearly half of commercial real estate debt is loans from banks (mostly from smaller banks, because regulations discourage large institutions from this type of lending). The rest are securities or loans from insurance companies. The Office of the Comptroller of the Currency, a regulatory body, reportedly advised the New York central bank to write down the value of some of its loans more aggressively, making this clear when it reported its results on January 31. Across the pond, the European Central Bank has asked banks to set aside additional reserves to cover loan losses on commercial real estate.

The strength of the US economy provides additional protection. If we look at the skyscrapers of New York, it is easy to feel anxious. But look at street level and you can calm down. The streets are full of people. The stores are crowded. Restaurants are full. America is moving, though it could use a bandage on this ugly wound…

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