U.S. Commercial Real Estate: “It’s Going to be Ugly”

“The party’s over, unfortunately.”

The CEO of a real estate investment firm just made that comment about the U.S. commercial real estate market.

In an April 19 Yahoo! News article headlined “’It’s going to be ugly’: This CEO just issued a dire warning about US real estate …,” the executive also said “The office market’s going to be destroyed, hotels are going to be destroyed …”

Expect a torrent of defaults ahead.

The April Elliott Wave Financial Forecast provides details and insight into the U.S. commercial real estate market:

The faltering of the commercial real estate market should come as no surprise to [Elliott Wave Financial Forecast] subscribers. In May 2022, EWFF observed that “bellwether [office] markets, such as New York and San Francisco, face gluts.” In October, EWFF tracked the developing weakness across the full breadth of the commercial property market in the form of a completed five-wave rise in the Green Street Commercial Property Price Index (see p.9). Here’s the title we placed on the chart: “The Work-At-Home Bust Begins.” The index is now down 15% since May of last year. In October, EWFF added that it was only the beginning of what should become a “years-long decline.” This potential is acutely apparent in the bellwether markets EWFF cited in May. According to the San Francisco Chronicle, San Francisco’s office vacancy rate is 29.4%, “a record high.” New York’s vacancy rate hit a record high of 18.6% in December. The likelihood of a much deeper decline is symbolized by the public auction of the Flatiron Building; the first public auction of the iconic 5th Avenue structure since 1933, in the aftermath of the Supercycle wave IV bear market. The winning bid of $190 million had to be vacated on March 24 when the high bidder failed to come up with the 10% down payment.

In March and October, EWFF made the case for a “new era of defaults,” which clearly made an appearance in the first quarter of 2023. It started as a trickle in the first two months of the year as a few property developers failed to make payments. Then, on February 24, Brookfield Properties defaulted on $780 million in notes on two LA office properties. Brookfield said at the time, “We are generally seeking relief given the circumstances.” By March 8, the Commercial Observer noted that the “flood” was on, as Brookfield’s action provided “cover for other institutions to do the same:”

A Flood of Defaults Swamps

Big Names, Especially Offices

As EWFF anticipated in October, the Observer traced the change to “workers’ embrace of work from home arrangements. Once viewed as a temporary measure forced by the pandemic, virtual work has outlived the era of social distancing. The dam holding back default filings clearly burst.” With high vacancy rates generating less income to service debt and property prices falling, owners are getting hit by a “double whammy” that “squeezes loan-to-value ratios and hampers owners’ ability to refinance.” Throw in rising rates, and the numbers just don’t add up.