A Slight Office Apocalypse

Here are the MSCI real estate figures in Europe for Q1 2023:

• Deals worth €36.5 billion ($40 billion) in total or -62% YoY (most major real estate sectors and national markets went down).
• The number of offices sold (the largest commercial real estate sector) fell to a record low, with deals worth €10.8 billion ($11.94 billion) being the lowest level in the last 13 years.
• Investment in commercial real estate fell to the lowest level in 11 years.
• The industrial sector demonstrated a sharp decline in investment sales among the main types of real estate: deals worth €5.4 billion or -76%.

Figures in a nutshell

• Estimated valuation keeps adjusting to rising interest rates and a weak outlook.
• The tenants’ needs are changing toward higher quality assets (transitioning to a hybrid model, focusing on energy efficiency, etc.)
• A serious reversal in the industrial sector (given that the industry enjoyed the flow of investments and price increases in the post-pandemic period).

Countries in a nutshell

✓ The UK remained the largest European commercial real estate market with €11.3 billion or -59% YoY. Also, France, Germany, Spain, and the Netherlands hit the top five.
✓ Practically all eurozone countries saw a drop in sales, but France and Spain did worse than others due to local trends: an annual decline of 40% and 13%, respectively.
✓ Paris overtook London as Europe’s top investment hub with the three biggest deals this quarter. Deal volume in Paris remained unchanged (=€5.3 billion YoY).

Europe’s situation is clear; let’s get to the USA (where it’s similar)

• Compared to Q1 2022, which turned out to be the busiest first quarter on record, sales across all real estate types fell 56% to $85 billion (it’s a long-term pre-COVID level with first-quarter average sales of $88 billion from 2005 to 2019).
• Office real estate sales both downtown and in the suburbs plummeted. And CBD offices fared the worst, with 77% below average deal volume.
• Despite a sharp decline in deal volume and a drop in US commercial real estate prices, distressed sales are still insignificant (1.4% of the total amount).
• No commercial real estate sector looks secure. However, the real concern is office space, which makes up about a quarter of all commercial real estate (and its debt).

Key takeaways

• A recent JPMorgan investor survey showed that commercial real estate was the most likely cause of the next financial crisis. Also, some of the largest US-based banks chose it as a problem area.
• Here are the latest ones: Blackstone #BX (the world’s largest asset manager with $991 billion in AUM with over 12,000 real estate assets) reported a sharp drop in Q1 earnings because of the slowdown in the growth of the commercial real estate sector and the difficulties in selling part of the assets. #BX limited withdrawals from its real estate income trust following a surge in foreclosure applications.
• All real estate appraisals get undermined by %% rates that drive up landlords’ costs. Plus a banking shake-up and a recession when workers get laid off, and their former employers lay off staff members. Taken together, all this is all-important for two interconnected US industries:
1. Real estate (if empty office buildings are unlikely to be filled again and will cost only half of the investment);
2. Finance (a recent classic: Asset manager Brookfield #BN defaulted on LA’s two huge office towers now taken by the largest banks, Citigroup #C and Morgan Stanley #MS, instead of refinancing $784 million in debt on loans);
3. Losses from commercial real estate will make things worse in the banking system.