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US office buildings are facing a 30% price drop as remote work continues to upend the sector, Morgan Stanley says

FILE PHOTO: A man walks past The Gherkin and other office buildings in the City of London, Britain November 13, 2018. REUTERS/Toby Melville/File Photo
FILE PHOTO: A man walks past The Gherkin and other office buildings in the City of LondonThomson Reuters
  • Office buildings are facing a 30% peak-to-trough price correction, Morgan Stanley warned.

  • The sector has yet to fully adjust to the massive disruption of remote work.

  • US commercial real estate is headed for a $2 trillion wall of maturing debt in the next few years.

America's office market is in flux and prices have further to fall amid "secular" challenges facing the sector, Morgan Stanley analysts said in a note.

The bank pointed to persistent pressure weighing on the office property market, with prices already having fallen around 20% from their peak, according to data from Real Capital Analytics cited by Morgan Stanley.

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That's largely due to persisting work-from-home trends from the pandemic, even as other aspects of life return to the pre-COVID norm. Most workers commute to the office just a few days a week, strategists estimated. A July survey from the National Association of Realtors found office vacancies to be at an all-time high last year, notching 13.1%.

Demand pressures will likely drag on, sparking a 30% peak-to-trough correction in office prices, the bank said of its base-case scenario.

"Office as a property type is confronting a secular challenge," the bank said in a note on Sunday. "We are unlikely to see demand for office properties returning to pre-pandemic levels. This means that property valuations, leasing arrangements, and financing structures must adjust to the post-pandemic realities of office work. This shift has begun and there is more to come."

A specter of debt also looms over the broader commercial real estate sector, with around $2 trillion of commercial mortgages approaching maturity over the next few years, Morgan Stanley estimated. That debt will soon need to be refinanced, likely at higher rates, and for office properties, likely at lower valuations.

Signs of distress are already emerging, particularly in the office space. Late payments on office-backed loans surged to 6.5% in the fourth quarter, according to the Mortgage Bankers Association. Commercial real estate pain has been a source of anxiety for the US banking sector, and regional banks in particular. Fears that smaller lenders will soon be saddled with billions in soured mortgage debt recently caused a fresh bout of stress, with shares of New York Community Bank last week plummeting partly on concerns over its commercial real estate exposure.

"It goes without saying that regional banks with office prominent in their CRE exposures will face more challenges," strategists said. "Banks with higher exposure to CRE tend to have a lower CRE reserve ratio. Thus, the challenges facing CRE in general and office loans in particular are intricately linked to the regional banking sector."

Real estate pros have been sounding the alarm on commercial real estate since early 2023 when the sector was in the spotlight following a spate of regional bank failures. Some office buildings could become practically obsolete due to demand struggles, real estate execs have warned, which could require those buildings to be converted into other property types or demolished.

Read the original article on Business Insider