It’s a bad time to be an office landlord

Is commercial real estate the next domino to fall in our creaking global economy? A growing number of signs point to very possibly.

Driving the news: A batch of new data paints a picture of a commercial real estate market—urban offices, in particular—under extreme stress in cities worldwide.

  • In Europe, prices are down 20% in the past year and dealmaking has fallen to an 11-year low, a sign that lenders and investors are backing away from the space.
  • In the US, the office vacancy rate has reached a record high of 12.9%, and Morgan Stanley predicts that office and retail property valuations will crater by up to 40%.
  • In Canada, office vacancies are even higher, at 17.7%. In Toronto, the vacancy rate is 19%, the highest ever recorded and more than quadruple the level immediately before the pandemic.

Why it’s happening: Commercial real estate is facing a perfect storm of headwinds. Higher interest rates have pushed down property values and raised the cost for landlords to borrow money, while the persistence of remote work is causing companies to abandon or downsize offices.

  • That’s trickling down to other sectors of the commercial real estate market, like retail—with fewer people coming into offices, retail businesses in downtown cores have suffered and demand for space in those areas has dried up.

Why it matters: A major downturn in commercial real estate would be bad news for banks and investors, who are commercial landlords’ chief lenders, but likely not life-ending. 

  • They’ll take losses if property owners can’t pay their debts, but in Canada, office properties only account for 2% of the big banks’ loan portfolios.

The bigger risk may be to the economy as a whole. Commercial real estate is often a reliable driver of growth coming out of a recession, as companies staff up and downtowns boom. That’s not likely to be the case in this cycle. If we do go into recession our recovery could be slower as a result.—TS