Growing Unease About a Wall of Debt for Office Building Owners

Bonds issued by Alexandria Real Estate Equities Inc. (ARE), Hudson Pacific Properties Inc. (HPP), and Vornado Realty Trust (VNO) have also experienced a decline in value during this period.

It is important to note that the REITs mentioned above have not provided any comments on this matter.

The pressure on office REIT bonds can be attributed to the increasing costs and scarcity of debt at the property level. As the pandemic continues to impact businesses, many U.S. companies are still in the process of optimizing their office spaces, which has further affected the market.

Pimco, a leading bond investment firm, believes that there are opportunities for lending in commercial real estate at both the asset and holding-company level. According to their analysis, the current situation in this sector is the most disrupted since the global financial crisis in 2007-2008.

In a recent note to clients, a team of portfolio managers at Pimco, led by Jamie Weinstein, highlighted that the current dislocation is primarily driven by capital markets. Rising interest rates have led to a compression of valuations, increased financial market volatility, and reduced liquidity in both public and private debt and equity.

For a visual overview of office REIT debt coming due by maturity, please refer to the BondCliQ chart provided below:

REITs Face Significant Debt Refinancing Challenges

According to Morgan Stanley analysts, Real Estate Investment Trusts (REITs) are expected to refinance approximately $124 billion of corporate debt by 2025. The average interest rate on this debt is relatively low at 4.1%. However, office building owners are particularly at risk due to the high number of vacancies in the office sector.

In addition to the issue of record-high vacancies, commercial property owners also face the challenge of higher borrowing costs. The Federal Reserve has raised its policy rate to 5.25%-5.5%, the highest it has been in 22 years, in an effort to combat inflation.

As a result, REITs can expect significantly higher borrowing costs of around 6% or more for 10-year loans. This is in contrast to the current interest rate of approximately 4% on their maturing debt. The Morgan Stanley team predicts that interest costs will increase by $24.7 billion to $27.1 billion as this debt is refinanced.

To put this increase into perspective, it is roughly equivalent to NASA's budget request for 2024.

However, not all REITs will be negatively impacted by these challenges. Mortgage REITs, in particular, have the potential to benefit from the ability to charge borrowers higher interest rates. This has drawn the attention of billionaire investor and Pimco co-founder Bill Gross.

While benchmark 10-year Treasury yields edged higher on Thursday, reaching 4.32%, they still remain below the highs of 5% seen in October. This is due to investors embracing the idea that inflation will ease, resulting in Federal Reserve rate cuts next year.

In November, stocks experienced mixed performance but are set to record significant gains for the month. The Dow Jones Industrial Average (DJIA) is up 8.1%, the S&P 500 index is 8.4% higher, and the Nasdaq Composite Index has advanced by 10.2%, according to FactSet data.