$1.2T of Debt Facing Default Risk

Good morning,

$1.2T of debt facing default risk, smaller office leases reflect hybrid work’s impact, home builders thrive despite rising rates, and WeWork seeks debt restructuring to avoid bankruptcy. Let’s delve into today’s topics.

📈 Market Update

⌛️ $1.2T of Debt Facing Default Risk

Over $1.2T in CRE debt is potentially at risk due to high leverage and falling property values, according to Newmark Group, with offices accounting for the largest share at over $600 billion. Half of this debt is coming due through 2025 just as property values have declined significantly amid rising interest rates, putting borrowers at risk of default as refinancing becomes more difficult and costly. Newmark expects defaults to rise as highly leveraged landlords are motivated to return keys rather than inject more equity into buildings with dimming prospects, noting that banks carry the greatest exposure with over $300 billion of the risky office loans maturing soon.

🏘️ Home Builders Thrive Despite Rising Rates

Despite rapidly rising mortgage rates reaching their highest levels in over 20 years, the U.S. housing market has shown unexpected resilience so far. New home sales rebounded in July to their highest pace since August 2020, before the pandemic hit. This strength is attributed to high demand fueled by low supply of existing homes for sale, as current homeowners are reluctant to give up their low mortgage rates by selling. As a result, home prices have held up well, providing support to homebuilder revenues. However, there are signs this strength may be temporary, as mortgage applications for new home purchases dropped to a nearly 3-decade low last week.

Looking Forward:
While the housing market has defied expectations so far, persistently high mortgage rates will likely dampen activity going forward. Rates on 30-year fixed mortgages have continued climbing this week, now approaching 7.5%, constraining affordability. This will likely sideline some prospective homebuyers, especially as home prices remain elevated. The rising rates also lock existing homeowners into their properties, as they are unwilling to give up relatively low rates. This reduces housing supply further and impedes labor mobility. Ultimately, the spike in mortgage rates, if sustained, could lead to declining home values and presents a headwind for the broader economy.

🏢 Smaller Office Leases Reflect Hybrid Work's Impact

Despite an increase in office leasing activity this year, the average office lease size has shrunk by 19% compared to pre-pandemic levels according to CoStar Group, as companies commit to less space long-term amid hybrid remote work policies. With the US office vacancy rate rising to 13.2% and projected to hit 17% by 2026, businesses like IBM, Fluor, Aon, and law firms are renewing leases for substantially less square footage. While some growing companies still expand their footprints like Davis Polk in New York, the overall market is contracting under pressure from remote work, evidenced by over 200 million square feet of available sublease space.

🥲 WeWork Seeks Debt Restructuring to Avoid Bankruptcy

WeWork is engaging restructuring advisers Hilco, Alvarez & Marsal, and law firm Kirkland & Ellis to help renegotiate its substantial lease obligations and avoid bankruptcy. After a disastrous failed IPO attempt in 2019 led to its CEO's ouster, WeWork has continued to struggle with low office demand and occupancy amid remote work trends, sending its shares down 97% over the past year. With its ability to stay solvent in doubt, WeWork aims to terminate or rework expensive leases to cut costs and restructure its unsustainable debt load out of court.

✍️ Further Reading

• Powell Is Using Jackson Hole as Final Push in Inflation Fight (BBG)

• The City Where People Aren’t Going Back to Offices (WSJ)

• Here’s Why a Big French Retail Owner Changed Its Mind on US Malls (CS)

• Toronto REIT To Sell Stake in 54 Properties South of the Border (CS)

• Multifamily Developer Confidence Positive Despite Near-Term Headwinds (GS)

• Dog Art Class, ‘Yappy Hour’ Treats: Luxury Apartment Buildings Add Pet Amenities (WSJ)

• When Will Texas’ Multifamily Rollercoaster Ride End? (RD)

• Veritas has Troubled Loans in San Francisco. Is LA Next? (RD)

• Don Peebles: A Great Opportunity to Reposition Office Buildings to Address Housing Challenges (CNBC)

📊 Chart of The Day