March 12, 2021/Fitch Ratings
Cash flow stresses to Fitch Ratings’ portfolio of rated US CMBS office single-asset/single-borrower (SASB) transactions that simulate a permanent decline in demand for space as a result of increased remote work have a severe impact on Fitch-implied property values, Fitch Ratings says. Our new report WFH Secular Shift Will Pressure U.S. Office Properties discusses potential credit implications of hypothetical declines in demand, rent and net cash flow on 2012-2020 vintage office CMBS transactions. Under scenarios of moderate and severe stresses, 4.4% and zero, respectively, of 114 SASB bonds maintain their current ratings.
The moderate stress scenario assumes employees work remotely 1.5 days per week, resulting in a 20% decline in office workers and a 10% decline in office space demand, reflecting our expectation that space may not shrink in direct proportion to the reduction in workers in the office. The severe scenario doubles these assumptions. We assume rents decline at 1.25x the decline in space demand, as increased vacancies magnify declines in rent levels.
The two stress scenarios result in declines in net cash flow of 15% and 30% under the moderate and severe scenarios, respectively. The two scenarios use cap rates from Fitch’s most recent surveillance review, 7.23% on average, which are significantly higher than the appraisal cap rates at loan origination, which are 4.73% on average.
These assumptions result in average market-value declines from at-origination appraised values of approximately 44% and 54%, respectively, for moderate and severe scenarios. Were these declines in value to occur, downgrades are possible, with 25% and 55% of investment-grade bonds potentially moving to below investment-grade under the moderate and severe scenarios, respectively. The stresses applied in our current rating analysis already reduce property values by 38% on average.
US office property values fell approximately 43% during the 2008 Great Recession and recovered over a three-year period. The secular shift to working from home may prolong the recovery in values following this recession.
