Post-Covid World: Commercial Real Estate Investors Grapple with Unprecedented Losses

In the wake of the Covid-19 pandemic, commercial real estate investors are bracing themselves for significant losses. Experts warn that struggling property owners should consider selling their properties now, as the shift towards telework becomes a stable policy in the post-pandemic era. The question on everyone's mind is this: if people continue to forgo malls and office spaces in favor of remote work, how safe will these buildings be?

For seasoned commercial real estate investors, rising interest rates, persistent inflation, and tough economic conditions are nothing new. They have weathered these storms in the past, waiting for rental demand to increase and borrowing costs to fall. Typically, cyclical downturns in demand do not drive them to sell off their office buildings and shopping malls, as long as lenders remain confident in their ability to repay the loans and the property values remain higher than the loan amounts.

However, the landscape is changing rapidly. With telework becoming the policy of choice for many companies and consumers increasingly turning to online shopping, cities like London, Los Angeles, and New York find themselves flooded with buildings that are either unwanted or no longer necessary. Consequently, the recovery of skyscrapers and sprawling malls in city centers could be significantly delayed. If tenants are not found quickly, owners and lenders face a higher risk of financial loss compared to previous cycles.

According to Moody's, global banks hold approximately $3 trillion in commercial real estate loans, with most of them maturing between 2023 and 2026. US banks have already witnessed a spike in real estate loan losses in the first half of this year and anticipate further losses. These banks also state that loans provided to US office and industrial real estate investment trusts (REITs) are now 17.9% more likely to default compared to just six months ago. Likewise, borrowers in the investment and property development sector in the UK face a 4% higher default risk.

Despite these vulnerabilities, some global policymakers remain hopeful that the shift in work habits post-pandemic will not lead to a credit crisis like that of 2008-2009. However, demand for loans from companies in the euro area has hit a record low, signaling a decrease in confidence. In the US, banks are expected to experience a lower loan loss rate in 2023 than in 2022, even in the extreme version of the Fed's annual stress tests that assumes a 40% decline in commercial real estate values. Meanwhile, the average commercial property value in the UK has dropped by about 20% from its peak, but banks have not suffered significant loan losses due to reduced exposure to the real estate sector compared to 15 years ago.