Link to Article: PGIM CEO expects 60% of office buildings to enter purgatory You know I love dissecting Audacious Headlines, let's look at data and my real life example. If you do not have time to read the entire article, please allow me to extract and apply the relevant.
First, scare me.
“We are going to have a big workout for that purgatory set over the next 24 months. Prices will come down and they will really plunge is in older buildings."
Now some stats please
"Hunt predicted that 60% of buildings can’t meet tenant or investor expectations in climate (read ESG) or hospitality (as in the ability to woo workers back into the office). They will require serious remediation to be competitive in a market that could well see lower need of office space. And the bottom 20% of properties, if financed with non-recourse loans, will probably land back in the lender’s lap."
What data supports these conclusions?
"A Trepp analysis (stressed) interest levels from 5.5% to 7.5%, calculating the weighted DSCR at each stage, and put together tables showing effects overall. Overall (at 5.5%), 27.9% of properties would have a DSCR under 1.25 times. At 6.5%, more than a third (35.6%) would be in the DSCR danger zone. At 7.5% loan rates, it would be 44%."
To clarify, the minimum DSCR (debt service coverage ratio) most lenders accept is 1.25X, which means your NOI must be 1.25 times greater than your mortgage payment. This requirement is not universal and can be adjusted deal by deal, but has been a standard in lending for decades.
"Other research suggests a growing wave of so-called Zombie office buildings in gateway cities with a utilization rate of under 50%. A recent report by the Boston Consulting Group found that, on average, vacancy rates have increased from 12% to 17%, and utilization has dropped from 70% to 42%."
Utilization rate is relatively new. Lenders are now trying to calculate the percentage of space being utilized on a daily basis. A higher utilization rate decreases the probability a tenant may downsize. As a mortgage banker, we are asked to calculate.
How about a real life example. We are part of a larger group of mortgage bankers with $7.5 billion in 2022 originations. Early this week, we compared notes on lenders currently quoting office. In the past week, we collectively presented loan requests to lenders from small and large markets, higher and lower LTV's, and small and large balance. The list total 30 non-bank lenders, 29 passed. Not on the list, CMBS lenders. Fortunately, they will consider office up to 65% LTV and are currently quoting +/- 375 bps over the index. CMBS is a viable debt source and may be the best option for many borrowers.
My conclusion, all office is being painted with the same brush. With overcorrection, comes opportunity.
Contributed by: Kyle Nagy
About Kyle:
Kyle Nagy is a founder and Director of CommCap Advisors. Kyle started his commercial real estate career in 1999 as the Real Estate Analyst for the Las Vegas office of GMAC Commercial Mortgage, an international real estate finance company. Prior to leaving and forming CommCap, Kyle was instrumental in the growth and success of the Las Vegas GMAC office and was one of the youngest Vice Presidents within the company. During his finance career, Kyle has successfully originated, underwritten, and closed over $900 million in loans with Life insurance Company, Wall Street Conduit, Bank and Agency Lenders.
knagy@commcapnv.com
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