The K Shaped Recovery: Looking Into the Future of Office with Moody’s Analytics
Between rate hikes, office woes, and the looming threat of regulatory investigation, CRE lenders can use all the help they can get keeping their books in good working order. The Real Deal sat down with Moody’s Analytics’ Commercial Real Estate Industry Practice Lead Jeffrey Havsy to get his take on the future of office and to learn about the tools that his firm has developed, tools that not only keep CRE lenders in good regulatory compliance but also help them mitigate risks and take advantage of opportunity when it arises. Havsy, an industry veteran with decades of experience including a stint as America’s Chief Economist for CBRE, walked us through his assessment of the office market, explaining how the recovery may not be as one-sided as some fear, as well as told us about some of the ways that Moody’s is helping CRE lenders when they need it most.
What’s Really Going On With Office?
When it comes to Commercial Real Estate, the word on everybody’s lips is office. “Our view on office is that, yes, we are nearing the bottom, but we’re not expecting a V-shaped recovery,” says Havsy. “My colleagues and I were talking the other day about how we think of it more as a K.” Havsy and his team see office moving in two directions going forward: top tier, or Class A, office space will continue to see significant demand as firms in this space streamline and develop ways to incentivize their workforce to return to the office with a purpose, while mid tier, or Class B/C, office space is oversupplied and will see a significant reduction in demand. “There is a lot more B/C space, where rents are falling, concessions are rising, and utility costs are higher. So for a lender, that’s going to impact cash flow,” says Havsy, who points out that, in the long run, this office space is “going to be a stressor on the lender because they’re going to figure out, ‘Hey, I don’t want the keys.’”
Lenders with exposure to this category of office space must address both short- and long-term problems. In the short-term, lenders need to understand and have a plan for mitigating their risk, both to soften the blow to their books and keep regulators from initiating a costly and time-consuming auditing process. “If you’re on top of it, if you have a plan, if you can show you have analyzed your lending book and you know where the issues may lie, regulators are going to treat you with kid gloves,” explains Havsy. “But if you haven’t done your homework, that’s when the fist comes into play.”
In the long-term, lenders with high exposure to failing office stock have a myriad of ways to salvage what could otherwise be a losing investment. “Maybe we convert a few of these office buildings to apartments,” says Havsy, “and maybe some of that becomes a hotel, and another piece becomes a data center, and then some gets knocked down.” While not an overnight fix, finding a diverse set of solutions for getting failing office space off a lender’s books is, ultimately, how the CRE industry has always corrected and recovered. As Havsy explains, “a bunch of little things add up over time to remove enough of that obsolete stock.”
Know Your Exposure and Have A Plan
Navigating your way through the treacherous waters of the office market right now is no easy feat for a CRE lender, but there are some simple practices and tools one can use to ensure the smoothest voyage possible. Havsy laid out a series of questions lenders need to answer before creating a plan of action: “Do you have ways to analyze your lending book? To understand your industry concentrations? What are your property type concentrations, your tenant concentrations? Do you understand the geographic concentration on your loans?” Asking these questions can reveal previously-invisible risks or strengths that shape a lender’s strategy going forward. Take, for example, geographic concentration. If a lender’s portfolio is 30% office, but that space is spread out across a number of markets, their risk is lower than if all of their office space is concentrated in, say, Miami or Chicago. Lenders who understand their exposure at every level have an advantage on the competition.
This work pays off double when it comes to regulatory compliance. “Regulators really want to know, what have you done? What process have you taken to analyze your risk?” says Havsy, who explains that regulators have gotten more wary of systemic risk in the post-2008 environment. “Regulators have learned that they really need to look at a lender’s portfolio on a holistic level, because credit risk, liquidity risk, even environmental risk all affect one another.” When it comes to regulators, Havsy says that lenders want to get “the velvet fist, not the knuckles.”
How Moody’s Can Help
Of course, lenders need accurate data and robust analytical tools in order to make their plan. Take Moody’s Portfolio Monitor for example. With Portfolio Monitor, lenders can run reports to assess the geographic concentration of their loans, get synthetic credit ratings from their tenant credit information, and much more, all with the advantage of Moody’s robust trove of normalized data. “Getting the data to flow is a challenge,” explains Havsy. “Let’s take the example of Bed, Bath, & Beyond. They went into bankruptcy recently, so you want to know what your exposure is if you’re a lender. But depending on your systems, it might be in your loan book as some combination of BBB, or BB&B, or Bed Bath, or BB and B.” Ensuring that your data is accurate may seem like a simple task, but small mistakes can ripple out and create massive problems if not addressed early on in the process. “Using the tools that Moody’s has to make sure you’re crossing all your T’s and dotting all your I’s for compliance is the first step,” says Havsy. “Because if the regulators have to come in, you’re going to be distracted, you’re not going to be able to grow.”
This article was produced by The Real Deal’s Brand Studio Team in conjunction with Moodys Analytics. For more information about working with our Brand Studio Team please click here.