Office landlords hit hard by the work-from-home revolution are resorting to a desperate measure in the real estate world: “return the keys.”
In this case, the landlord stops paying the mortgage on the office building or refuses to refinance. The bank or investors who granted the loan then take possession of the building again.
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Some of the biggest names in commercial real estate, such as Brookfield and Blackstone, have defaulted on their mortgages and have begun or completed the process of turning back the keys to office towers. The tactic shows both the extent of the problems in the office market and the ability of large real estate companies to shift much of the financial burden to others – in this case banks and other lenders.
Since the start of the pandemic, office workers have shown they can do their jobs from home, and many have been hesitant to return. And companies realized they could save a lot of money by renting less office space, making many office towers unprofitable for their owners and turning many business districts into ghost towns. About 23% of office space in the United States was vacant or available for sublease at the end of November, compared to 16% before the pandemic, according to Avison Young, a real estate services firm.
Returning the keys is a drastic step but makes sense as it can limit the landlord’s losses on a building.
Consider a real estate company that bought an office tower for $100 million just before the pandemic, investing $25 million of its own money and borrowing $75 million. If the building has a tenant decline and is now valued at $45 million, the landlord’s initial investment could be worth zero – and the reduced rental income may not be enough to cover the building’s costs.
Instead of continuing to pay interest and other costs, the landlord may decide to default on the loan payment, meaning the lenders get the distressed building. And in theory, lenders could incur a loss of $30 million – the difference between the amount they borrowed ($75 million) and the resale value of the building ($45 million).
Today’s return of the keys is reminiscent of the term “Jingle Mail” that became infamous after the 2008 financial crisis, when homeowners abandoned their homes – and allegedly returned their keys to their banks – because their homes were worth far less than they had paid for them Mortgage owed.
But there is a difference: Large real estate companies can continue their business even after a default and are even considered smart when it comes to dumping distressed buildings. But homeowners who defaulted on their mortgages saw their credit scores deteriorate significantly and were forced to find somewhere else to live.
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