Work-from-home creates mortgage-backed securities default risk

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According to a new report by rating agency Moody’s, the popularity of working from home in the US is so severely constraining income from office towers that some commercial mortgage-backed securities are at risk of default.

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“Lenders’ expectation of lower office earnings is creating refinancing difficulties for office loans with low debt yields and loans with significant lease terms over the next 36 months,” the March 20 report said.

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Historically, commercial mortgage-backed securities, which draw on the proceeds from a range of commercial mortgages, have proven beneficial to investors because they generate reliable cash flow at a fixed interest rate and come with prepayment penalties that protect borrowers from prepayments hold Ensuring cash flow is maintained throughout the life of the loan.

However, as companies shed office space, commercial property rents are falling, reducing overall cash flow for office towers and potentially weakening borrowers’ ability to repay their debt.

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According to Moody’s, office revenue has already fallen about 10 percent below what would be expected based on robust US employment numbers

“Sales will remain particularly strained in markets with (1) a large concentration of industries such as technology that have adopted high levels of hybrid work and (2) difficult commutes,” the report said.

Lower office occupancy has led to record office vacancy rates in some US cities. And based on commercial real estate firm CBRE’s forecast, vacancy rates are expected to continue rising into 2024.

CompStak, a US provider of lease data quoted in the report, says the average office lease has 5.1 years left. In other words, the higher market vacancies and lower rents will not be reflected in concrete office cash flows for some time.

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Still, national vacancy rates rose five percent between Q4 2019 and Q4 2022, while rents fell 2.3 percent.

Of the 25 largest office markets, San Francisco saw both the highest increase in vacancy rates, at 13.5 percent, and the sharpest declines in asking and rental rents – down 13 percent and 31 percent, respectively. San Francisco’s rental income ratio has reportedly returned to 2014 levels, while Charlotte, NC saw the most notable growth in both asking and rental income — up 9.5 percent and 6 percent, respectively.

In contrast, Central New Jersey saw the smallest increase in vacancies, up just 1.2 percent.

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