More Office Delinquencies On the Way, Says Moody’s Analytics

Many economists have started to ask whether a soft landing — an ultimate reduction of inflation without the appearance of significantly higher unemployment or a recession — might now be possible. Some indicators are looking positive, and yet there are complications in the details that urge some caution, such as June’s improvements being mostly due to some easier factors, with EY-Parthenon chief economist Gregory Daco pointing out on Twitter that the “free lunch is over.” Improvement will need to come from more slower core services prices.

There is another issue as well, as Moody’s Analytics points out. The firm thinks that CMBS data shows that ultimately “we expect delinquencies will rise, and values will fall, especially for ‘obsolete’ office properties.”

June saw an additional balance of $485 million of newly delinquent CMBS loans, which are running one to two months behind. About 61% of the new delinquencies came from office properties. That compares to less than 1% for industrial-backed loans.

“If we look at the data for only conduits, the delinquency rate for CMBS conduit loans increased by 11 bps to 4.62% in June 2023,” they wrote. “This was a result of $1.26 billion in newly delinquent loans, driven mostly by $706.5 million in office loans, followed by $268.7 million in retail loans. The office delinquency rate increased by 64 bps to 4.47%. Six of the top 10 largest newly delinquent conduit loans were office loans and two were secured by regional malls.”

Slightly more than 51% of the total came from properties in the New York metro and almost a quarter of the amount owes to one property in Brooklyn. “This class BC Office property, which was valued at $219 million in 2016, has a total sq. ft. of 471,500 and is currently 34% vacant.”

Not good news for the broader office market. “The road ahead for office properties appears daunting as companies re-evaluate their office use amidst the ongoing discussion on hybridization of the workforce,” the report said. While there does seem to be a concentration of newly delinquent loans in major metro areas, Moody’s posits that it could be due to the concentration of office properties, in particular B and C Class.

As Moody’s has been saying, even Class A office is no longer a safe haven, putting more operational pressure on owners. And B and C Class are doing worse.

There is only so much that general economic conditions can help the office market because the new usage dynamics of work-from-home and hybrid may have gotten a jumpstart during the earlier days of the pandemic, but they don’t seem to be disappearing.