MSCI Report: Commercial Real Estate Distress Surges to $24.8 Billion

**US Office Buildings in Distress Surpass Hotels and Retail:**
The Rising Financial Troubles in the US Office Real Estate Market

**Increase in Distressed Office Buildings**
At the end of the second quarter, the total value of financially troubled US office buildings reached approximately $24.8 billion, surpassing the previously leading commercial real estate sectors of hotels and retail properties. This marked a significant increase of about 36% from the previous quarter, as reported by MSCI Real Assets.

**Outpacing Hotels and Retail**
By the end of June, distressed retail properties, including malls, amounted to $22.7 billion, while distressed hotels accounted for $13.5 billion. Overall, the total value of distressed commercial properties, across all sectors, reached nearly $72 billion, reflecting a 13% increase from the previous quarter. This is the first time since 2018 that the office sector has overtaken both retail and hotel sectors as the largest contributor to marketwide distress.

**Additional Properties in Potential Distress**
In addition to the properties already in distress, MSCI identified an additional $162 billion worth of properties that could potentially face distress. These properties are affected by issues such as delinquent loan payments, high vacancy rates, or maturing debt.

**Factors Contributing to Office Sector Stress**
The US office sector faces higher levels of stress compared to other real estate sectors due to weakened demand caused by the widespread acceptance of remote work. Badge-swipe data from Kastle Systems Inc. reveals that office usage in 10 major US cities is currently at around half of its pre-pandemic rate on average. Furthermore, as of June 30, over 20% of US office spaces remained vacant, according to Jones Lang LaSalle Inc.

**Declining Office Building Prices**
Office buildings have experienced a significant decline in prices, with a 27% drop in the year leading up to June. In contrast, all commercial property types recorded a 12% decline during the same period, according to real estate analytics firm Green Street. This decline in prices has prompted corporate landlords like Blackstone Inc., Brookfield Asset Management Ltd., and Starwood Capital Group to stop payments on office buildings they consider to be unprofitable.

**Vulnerability of Office Properties**
Office properties with maturing debt are particularly vulnerable to financial stress. The rising borrowing costs resulting from the Federal Reserve’s interest rate hikes have made it challenging for property owners to refinance their debts. The Mortgage Bankers Association estimates that around $189 billion of debt on office buildings is due to mature in 2023, with an additional $117 billion due in 2024.

**In Conclusion**
The distress in the US office real estate market has surpassed that of hotels and retail properties. Weak demand due to remote work and high vacancy rates has resulted in significant financial troubles for office buildings. The sector is also facing declining prices and the vulnerability of maturing debt. These challenges indicate a critical need for the office sector to adapt and find innovative solutions to navigate the changing landscape of the commercial real estate market.