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Remote Working Is Testing U.S. Office Landlords' Credit Quality


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Remote Working Is Testing U.S. Office Landlords' Credit Quality

This article is part of a series of articles on potential impact of secular changes on office real estate globally.

The acceleration of remote working could result in a sizable drop in demand for office real estate in the next few years, putting pressure on cash flow and asset valuation. While the extent of the impact of this possible secular change is unclear at this point, this could have a profound impact on the office real estate sector and significant implications on office landlords' credit quality. To gauge the potential impact on rated issuers, we tested our ratings using the scenario analysis below on a sample of select office REITs and a sample set of office single-asset single-borrower (SASB) commercial mortgage-backed securities (CMBS) ratings.

Downgrade Potential Is Higher For The Next Two Years For REITs And CMBS

We tested our office REITs ratings under a severe and prolonged change in office real estate, revealing possible downgrades of one to two notches. We acknowledge this scenario is severe and less likely, but it's helpful to understand the potential impact on ratings. Our scenario assumes office REITs that are more exposed to dense gateway markets (New York City, San Francisco, Boston, etc.) face prolonged pressure from accelerated remote working and office downsizing trends.

Table 1

REITs Exposed To Gateway Markets

Boston Properties Inc.


Vornado Realty Trust


SL Green Realty Corp.


Kilroy Realty Corp.


Hudson Pacific Properties Inc.


Columbia Property Trust Inc.


Under this scenario, tenants will likely consider significant reductions in their office footprints upon lease renewal and we assume this demand-led downturn will be prolonged through 2024.

Key assumptions include:

  • Only 50% of leases are renewed at expiration;
  • Lease renewals at rates that are 25% lower effective rent (including higher lease concessions and tenant improvement);
  • Very few new leases due to slower-than-expected recovery from the pandemic-induced recession;
  • Cumulative occupancy declines of about 10% to the mid- to low-80% area (95% currently); and
  • 10% decline in same-property NOI in 2021, moderating to 5% decline annually from 2022-2024.

Under this scenario, we anticipate credit metrics to significantly worsen, with adjusted debt to EBITDA deteriorating by one to two turns by 2022 and further deteriorate by 2024. Other considerations for downgrades could include revised views of the REITs' business risk factors, such as a weaker competitive advantage. These factors could drive downgrades of one to two notches over the next two years. While there is downgrade potential, we expect the ratings for office REITs to remain in the lower end of the investment-grade spectrum, with some falling below investment grade.

Still, we assume REITs have the ability to implement mitigating measures such as cutting dividends or pay them in stock (while maintaining REIT status), cutting capex/development spend, and pausing or limiting acquisitions, although their ability to execute asset sales (or partial sales through joint ventures) in the public market could be constrained.

Chart 1


Chart 2


SASB CMBS transactions often involve the securitization of mortgage debt secured by large, class A office properties in gateway markets and are often sponsored by office REITs. Given this association, we wanted to analyze how our structured finance ratings on office-backed SASB transactions would perform in a hypothetical scenario. We identified 10 out of 72 transactions to review based on a mix of factors including exposure to heightened levels of tenant rollover or coworking tenancy. The table below provides further details.

Table 2

Sample Set Of SASB Deals
Lease expirations by SF percentage (%)
Deal Loan City Floating/fixed UPB (Mil. $) Lowest rating Loan sponsor Occupancy (%) 2021 2022 2023 2024 Fully extended maturity year
WFCM 2018-1745 1745 Broadway New York Fixed 175.0 BBB+ QSuper Board as trustee for QSuper 100 7.8 0.2 0.0 0.2 2028
WPT 2017-WWP Worldwide Plaza New York Fixed 705.0 BBB- New York REIT Inc., SL Green Realty Corp., RXR Realty LLC, WWP Sponsor LLC 91 2.9 0.1 0.0 32.9 2027
BAMLL 2015-ASTR 51 Astor Place New York Fixed 273.5 BB- Edward J. Minskoff Equities, Inc.; Edward J. Minskoff 100 0.0 1.8 0.0 43.9 2027
BWAY 2015-1740 1740 Broadway New York Fixed 308.0 B+ Blackstone Property Partners L.P. 96 0.0 77.3 1.0 0.0 2025
LBTY 2016-225L 225 Liberty Street New York Fixed 778.5 B- Brookfield Financial Properties L.P. 93 2.4 0.0 0.0 3.4 2026
NCMS 2018-850T* 850 Third Avenue New York Floating 177.2 B- HNA Group Co. Ltd.; Murray Hill Properties LLC 58 11.5 6.5 6.5 5.0 2023
GSCG 2019-600C# 600 California Street San Francisco Fixed 240.0 BBB- ARK Capital Advisors LLC 100 11.6 1.5 8.3 11.6 2024
CSMC 2017-CALI+ One California Plaza Los Angeles Fixed 250.0 B- Colony Capital Operating Co. LLC 88 27.1 6.3 0.1 4.6 2024
OMPT 2017-1MKT One Market Plaza San Francisco Fixed 975.0 B- Paramount Group Operating Partnership LP 98 17.4 13.5 0.0 0.4 2024
BAMLL 2016-ISQ^ International Square Washington Fixed 370.0 BB- D.C. Area Portfolio Upper Tier JV L.P. (Affiliated with Tishman Speyer) 74 8.6 27.5 5.4 0.2 2026
*NCMS 2018-850T: 850 Third Avenue is currently on Watchlist as the largest tenant's lease (Discovery Communications - 31.4% of NRA) has expired on May 31, 2020, and the loan is currently in a cash trap. #GSCG 2019-600C: Exposure to WeWork, largest tenant at the property (51.8% of NRA; lease expiration in 2035); The general partnership interests in the sponsors and ARK are owned 80% by WeCo (affiliated with WeWork) and 20% by the Rhone Group. +CSMC 2017-CALI: One California Plaza is currently on Watchlist due to two separate Cash Sweep triggers - one associated with the failed lease extension of the largest tenant and the other associated with the debt yield threshold. ^BAMLL 2016-ISQ: International Square is on Watchlist as the occupancy declined at the property. Note: Occupancy is reported as of Sept. 30, 2020 for all deals except for WFCM 2018-1745 and CSMC 2017-CALI, which is based on June 30, 2020.

To assess the potential impact on our ratings in this hypothetical scenario, we reduced our S&P values by an additional 10% from values that were already on average 40.4% below at-loan-origination appraisal values under our base case. This assumption is consistent with the same-property NOI decline of 10% in 2021 that we apply in our severe scenario for REITs. This assumption is also consistent with Greenstreet Advisors' CPPI 8% drop in office values in the prior 12 months. However, an important distinction is that our additional 10% decline in value is on top of already established value variances, as discussed in our base case below. Despite this difference, we acknowledge market values have declined in the past year and may continue to do so as sustainable asking rents will remain under pressure as availability rates continue to rise like they did in past downturns.

In our most recent surveillance review, the 10 sampled SASB transactions have an average S&P loan-to-value of 93.1%. An additional 10% decline to our S&P values would increase our S&P LTV to 103.4%. Most ratings impacted under this scenario would indicate potential downgrades of two to three notches, with a few outliers at either one or four notches. The severity of the potential rating actions in this downturn scenario would be more in line with actions taken in the prior 12 months to SASB lodging transactions placed on CreditWatch, as opposed to more severe rating actions taken on SASBs secured by mortgages on retail malls.

The 10 sampled transactions have heightened levels of near-term risk and SASB performance is more asset-specific and thus more subject to idiosyncratic risk. However, we believe our ratings should benefit from the fact they are based on discounted, through-the-real-estate-cycle valuations.

COVID-19 Accelerated The Adoption Of Remote Working

We expect the recovery for office REITs to lag the broader REIT sector given the cyclicality of office assets and the secular headwind arising from a greater adoption of remote working. The office sector was the last REIT subsector to recover after the Great Financial Crisis in 2008, and the recovery took several years. In addition to the cyclical impact that the current recession is inflicting on office demand, we expect a prolonged decline as more people work from home and there is no strong rebound in job growth. Remote working is not a new trend, but COVID-19 accelerated this shift and the impact could be permanent. Despite expectations that economic growth will be relatively robust over the next two years (S&P Global Ratings' economists forecast real GDP growth of 4.2% in 2021 and 3.0% in 2022), we expect office demand will remain relatively muted.

We believe economic activity will perk up, but recent job growth was weaker than expected. The jobs market started the year on relatively weak footing with a meager 49,000 payroll gains. If it weren't for temporary help services and state and local education, employment would have fallen for a second month in a row. The unemployment rate held steady at 6.3% in January, but this rate is nearly double the 3.5% before the pandemic. In our view, the pace of job growth will largely depend on the success of the vaccination rollout, which has thus far been slower than expected across the U.S. We don't expect the unemployment rate to reach the pre-pandemic level until sometime in 2024.

Office REITs entered this downturn in relatively good shape with high occupancy (low- to mid-90% range) and steady rent growth. Rent collections for office REITs remained high throughout 2020, in the mid- to high-90% range for office assets, even as most buildings sat virtually vacant since the onset of the pandemic in March 2020. Despite the favorable rent collections, office REITs felt an immediate impact because of their exposure to non-office assets (such as retail tenants) and ancillary revenue such as parking. We expect revenue from these sources to rebound in 2021 as rent deferrals from retail tenants are collected and parking revenue normalizes in the back half of the year.

Chart 3


Chart 4


Still, after the onset of the pandemic, fundamentals for office real estate deteriorated. Leasing activity dropped significantly given the low levels of office utilization and the uncertain timing of employees returning to their offices, particularly for employers in large cities. While expiring leases have resulted in higher-than-average retention rates given the pandemic-related uncertainty, tenants are often signing short-term extensions (three-year terms, for example) rather than full-term renewals (eight to 10 years) to maintain flexibility. We think employers are postponing decisions regarding their longer-term office needs while significant questions remain about the vaccine distribution and workers willing to go back to the office, but those strategic decisions will likely be more crystallized in 2021. Rent spreads upon lease renewals have contracted modestly, with more weakness exhibited in gateway markets such as New York City.

We think tenants downsizing their existing footprints is a growing risk, putting pressure on demand for office real estate. A recent survey by CBRE suggests that remote working could reduce overall office space demand by 15%. However, as many tenants are postponing leasing decisions until a more complete return to this office, it's difficult to predict the extent of the downsizings. In fact, renewals in midtown New York totaled 4.8 million sq. ft. in 2020, showing a 7% year-over-year increase, according to CBRE.

Logistics Puts Urban Markets More At Risk

Urban markets are more at risk, particularly New York City, due to rising supply complicated logistics, while suburban markets could benefit

The return to offices has been slow, particularly for densely populated cities such as New York City and San Francisco. Complicating this is the reluctance of employees to use mass transit, along with other logistical factors such as office layouts and elevator use. We expect a very slow return, with the majority of office workers not returning until the second half of 2021, and the pace largely depends on vaccine distribution.

The recent growth in the sublease market could also put additional pressure on rents, although the quality of these properties are generally lower and lack the amenities provided by higher quality properties, such as those within our rated office REITs. Subleasing has become a greater portion of available space in urban markets such as New York and accounts for about 24% of available space as of the fourth quarter of 2020. This is slightly higher than the five-year average of 20% and well below levels reached in the last recession. At 16 million sq. ft., sublease space accounts for about 4% of office inventory in Manhattan, while San Francisco has the highest portion of sublease space at 7.4% of total inventory, compared with a U.S. average of about 1.8% according to Cushman & Wakefield

Among the key urban markets, New York City is facing a larger supply while demand remains pressured. According to CBRE, midtown leasing activity was down 49% at 8.8 million square ft in 2020 as many tenants are postponing making long-term commitments to office space while net absorption was negative 10 million sq. ft. in 2020, the lowest level since 2008. Challenges in the coworking space, which had been a significant demand driver in office real estate, also contributed to the reduced demand for office space as these formats face social distancing restrictions and increased remote working arrangements have hurt their growth prospects.

On the flipside, suburban office assets could outperform urban assets given higher utilization and location in markets with more favorable job growth such as the Southeast in the U.S. or markets with greater exposure to life science and technology sectors with more favorable growth prospects.

The impact on office will be more gradual but could be more prolonged

Unlike retail REITs, tenant quality remains steady as office REITs' tenants are generally well capitalized and diversified across a multitude of industries (technology, health care, financial services, etc.). The top few tenants for office REITs usually account for less than 12% of annualized revenue and have predominantly investment-grade ratings. There is a larger proportion of tenants under distress in the retail segment. Public REITs own above-average assets (mostly class A) that should outperform the overall market in a downturn and also recover quicker. A flight to quality favors class A assets, which offer better air quality and layouts, along with greater security and technology embedded within the buildings, should enable a quicker rebound than lower quality assets.

Job growth, particularly for life science and technology-related tenants, could drive demand and the growth of tech tenants continues to drive the changing mix of the tenant base. For example, tech giants such as Facebook and Amazon continue to expand their office footprint and have signed sizable leases in New York City. Moreover, reversing the densification trend that has persisted since the Great Financial Crisis could mitigate the impact of remote working.

Chart 5


Chart 6


REITs Ratings Bias Remains Negative

Chart 7


Chart 8


We rate 14 office REITs, most are traditional office with two concentrated in New York City and one in San Francisco markets. Recent rating actions were decidedly negative because of our expectations for credit metrics to remain elevated.

Table 3

Rating Actions
Downgrades Boston Properties (BBB+/Stable/--), Mack-Cali Realty (B+/Negative/--)
Outlook revised to negative Vornado Realty (BBB/Negative/--), Brookfield Property Partners (BBB/Negative/--), Columbia Property Trust (BBB/Negative/--)
Outlook revised to stable Corporate Office Properties Trust (BBB-/Stable/--)

Under our base-case scenario, we forecast same-property NOI will remain slightly negative to flat over the next two years. We expect slightly worse performance for REITs exposed to gateway markets. We think this is a conservative base case given the historical same-property NOI growth of office REITs over the past five and 10 years at 3.8% and 2.0%, respectively. We expect declines in occupancy and effective rents from weaker leasing activity as some tenants downsize or request higher leasing concessions and tenant improvements upon lease renewal. However, we believe built-in rent escalators, new leasing from job growth, operating cost savings, and the EBITDA contribution from well preleased new development could mitigate some of the downside. Occupancy is expected to decline slightly to the low-90% range.

Under our base case, we also expect office REITs to maintain adequate liquidity. Office REITs are focused on pulling back future investments and building up liquidity, but only two out of 15 rated REITs cut their dividend so far (Vornado and Mack-Cali) compared with the more widespread cuts among retail REITs. Development risk remains significant, although we expect pipelines to contract as projects are completed. Still, projects under development could be delayed, with lease-up and cash flow contribution taking longer than expected. About 80% of development by rated REITs is preleased, mitigating some of this risk. Office REITs have a well laddered debt maturity profile and do not face significant refinancing risk.

Chart 9


Office REITs currently traded at the largest discount to net asset value (NAV) among publicly traded REITs, at a 30% discount at the end of 2020, while Commercial Property Price Index (CPPI) shows a 8% drop in office asset value according to Greenstreet Advisors. Although we have not seen a significant movement in cap rates because of the lack of transactions, we expect weaker cash flow prospects in the next two years to exert pressure on office real estate valuations, but we don't expect a dislocation given historically low interest rates. Asset values could also be under some pressure over the next year if bank lending standards tighten or stress in the broader real estate market emerges, particularly if distressed asset sales accelerates in 2021.

Office SASB Transactions In CMBS

Our rated U.S. CMBS portfolio contains 72 SASB transactions secured by office properties with an aggregate trust balance of $31.6 billion. Mortgage debt on office towers in Manhattan secure more than half of the transactions. About 13.3% are in the San Francisco and Los Angeles office markets. The remainder are scattered across other office markets throughout the U.S. including Houston, Chicago, Boston, and Washington, D.C.

Table 4

Top City Exposures By Balance
City State Rated deals UPB (Mil. $) UPB %
New York NY 37 17,297 54.7
San Francisco CA 4 2,130 6.7
Los Angeles CA 4 2,077 6.6
Houston TX 2 888 2.8
Chicago IL 2 710 2.2
Top 5 cities 49 23,101 73.1
Other 23 8,524 26.9
Total 72 31,625 100.0


In terms of vintage, more than half of the transactions were issued in 2017 or later. Though we have rated fewer SASBs in recent years, this trend coincides with the growing share of SASB transactions relative to conduits in recent years.

Table 5

Vintage Breakdown
Vintage Rated deals UPB (%)
2005 3 7.8
2012 2 3.9
2013 3 5.7
2014 2 2.8
2015 10 15.8
2016 8 9.9
2017 15 21.8
2018 15 14.1
2019 7 9.6
2020 7 8.6
Total 72 100.0

Commercial real estate analysis for CMBS is a recovery-based approach in our rating methodology and focuses on the estimation of an S&P long-term sustainable net cash flow and expected-case value. SASB transactions, in our view, are uniquely dependent on a recovery-based approach given their asset concentration relative to conduits, which are normally backed by larger pools of loans that are more diversified in terms of loan count, property type, sponsorship, and geographic location. S&P's expected-case values are typically -30%, -40%, or sometimes -50% below at-loan-origination appraised values, creating a considerable buffer to market value declines. These value variances or discount to market values are akin to a 'B' stress level, from which further reductions in recoveries are made at the 'BBB' and 'AAA' stress scenarios, as detailed in "Rating Methodology And Assumptions For U.S. And Canadian CMBS," published Sept. 5, 2012. Accordingly, though SASB performance is more asset-specific and thus more subject to idiosyncratic risk, we expect our ratings to maintain adequate overcollateralization in our base-case scenario.

This report does not constitute a rating action.

Primary Credit Analysts:Ana Lai, CFA, New York + 1 (212) 438 6895;
Senay Dawit, New York + 1 (212) 438 0132;
Secondary Contacts:Michael H Souers, New York + 1 (212) 438 2508;
Fernanda Hernandez, New York + 1 (212) 438 1347;
James M Manzi, CFA, Washington D.C. + 1 (202) 383 2028;

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