Financial crisis looms as property values tumble

In London, the declines around the city are not uniform, but value falls in unpopular areas are similar to the US cities. Picture: Oli Scarff/Getty Images

In most of the world’s major cities, the biggest area of looming financial crisis is the fundamental decline in the value of office blocks.

With only a few days before June 30, Australian superannuation funds with large investments in this asset class who have not brought their valuations into line with this global change are likely to face investigation if they are required to make write-downs during 2023-24.

In the US whether it be San Francisco, Los Angeles, New York, Chicago, or Atlanta the working-from-home syndrome has reduced the office space required so driving down values which are further battered by the rise in interest rates.

Very similar trends have taken place in London, Stockholm and Hong Kong.

Where US contracts have exit clauses, owners of office blocks are simply walking away from their equity, leaving the mess to the beleaguered bankers.

While the impact on each city is different, we’re looking at a trillion-dollar global catastrophe which is only now being appreciated.

In the US, values in impacted cities have fallen between 20 and 40 per cent.

In London, the declines around the city are not uniform, but value falls in unpopular areas are similar to the US cities.

Most in the property industry believed that once the Covid scare had subsided, office workers would return to their former work patterns, but skilled office people are refusing long commutes five days a week and are demanding to work at least part of the week at home or in an office space close to their home.

In Australia’s those superannuation funds that have decided to ride out the storm will need to have invested in first grade office blocks with long leases from financially secure tenants.

Those leases need to have locked in rent rises to offset the impact of high interest rates.

In such cases it will be the tenant that suffers because they will need to sublease spare space and almost certainly incur losses.

And if the first class building is surrounded by empty decaying buildings then its value will be impacted.

On the Australian office block scene, there have been relatively few big transactions because sellers don’t want to realise losses.

On the basis of those limited transactions, large property investor and developer Dexus has written down its office investments by 7.7 per cent. While that write down is substantial in global terms, it’s a minor adjustment.

To date, there is no evidence of major widespread write-downs of office block property by our superannuation funds – although their listed property trusts investments have been sharply marked down in line with world trends.

Many funds want to retain their current unlisted property values at least until after June 30 so that they will look good in the performance ratings for 2022-23.

This is a high risk strategy, particularly as some of the superannuation funds have separate property units with a high content of office blocks. Even balanced fund units have a significant proportion of office block investments.

Superannuation investors are redeeming and investing in units every day and if it emerges that Australian values must follow the rest of the world then superannuation funds will have had people withdrawing and subscribing at values that are have been too high for the buyers and too generous to the sellers.

I’m not going to undertake a roll call of the superannuation funds who are most at risk in this situation, but trustees should consider adjusting their property values before the week is out, so they don’t have inflated performance levels for the current financial year.

Meanwhile, it’s worth relating some of the stories that are coming out of the US and the UK.

In San Francisco, the working from home syndrome has been multiplied by the retrenchments in the high-tech sector and among groups like Salesforce.

The decline in the use of office buildings has affected the value of retail complexes which have large empty spaces.

Westfield has been hit in San Francisco.

If the trend continues then there will be safety issues which will leave large city office blocks in unsafe areas to commute to.

Many believe that empty office space should be converted to residential areas, but that involves a large investment in plumbing and fittings, which is usually not economic.

Columbia University research predicts that offices in New York will lose 44 per cent of their pre-pandemic value by 2029 because of the impact of remote work. The crisis will not be short term because buildings that have a large vacancy rates and need renovation will not be able to justify the spending.

Office vacancy rates in London’s West End are low because companies are looking for space in the best buildings and locations to help lure workers back.

That demand enables rents to rise even though companies are taking less space.

But London’s Canary Wharf district is in trouble with large vacancies. HSBC is looking for a new headquarters which sets the trend.