Some of the largest commercial real estate companies are starting to show cracks as rising interest rates exacerbate industry challenges set off by the covid pandemic when the labor market started shifting from office work to work-from-home.

The New York office vacancy rate is at a record high of 12.7 percent, according to CoStar data. In Manhattan, where fewer workers buy their morning coffee or get their drycleaning done in the city, remote work is costing merchants $12 billion a year.

New York-based real estate investment trust Vornado Realty Trust defaulted Dec. 21 on a $450 million mortgage loan, signs of continued challenges and slower leasing for the city’s commercial property market.

Vornado’s Fifth Avenue and Times Square joint venture defaulted on a loan tied to the retail property, where tenants include the luxury labels Harry Winston and Blancpain.

About 13 percent of full-time workers are fully remote compared to 59 percent who are on site full-time, while 28 percent are in a hybrid arrangement, according to new research from the Survey of Working Arrangements and Attitudes conducted by economists from Stanford University and The University of Chicago.

Companies are still grappling with the hybrid work policies of employees working just some days in the office, said Michael Franco, president and chief financial officer of Vornado, during a Feb. 14 conference call.

Hybrid work schedules are widely expected to be a new work norm, CoStar News reported.

“The financing market remains highly constrained” because of the Federal Reserve’s move to raise interest rates, Franco said. The commercial mortgage-backed security “market remains largely closed. Market won’t thaw until the Fed ends its tightening cycle.”

Boston Properties CEO Owen Thomas recently said “commercial real estate markets are in a recession,” Vornado CEO Steven Roth said on a conference call.

Office vacancies have increased across the U.S. since the pandemic sent workers home and made remote work the norm. The vacancy rate in the Los Angeles central business district was 22.7 percent in the fourth quarter of 2022, according to a Jones Lang LaSalle Inc. report.

As demand weakens for space, Brookfield Corp., the parent of the largest office landlord in downtown Los Angeles, has defaulted on $784 million worth of loans tied to two buildings rather than refinancing the debt. About $290 million was outstanding under the loan, Brookfield said. The firm did not get a rate cap on the loan, which was grounds for default. Rate caps have soared in price as interest rates have risen over the last six months, The Real Deal reported. 

The defaults have hit downtown L.A.’s office market hard, which saw more distress earlier this month when Oaktree Capital Management foreclosed on a 48-story office tower. 

A recent wave of commercial real estate defaults affecting malls could extend to office spaces hit by the work-from-home phenomenon, Bloomberg reported. The American Dream mall in New Jersey is being sued after defaulting on $389 million in debt to lenders. Large malls in New York and L.A. face foreclosure. “The mall business can provide a preview to the challenges owners and lenders of office buildings may face in the coming years,” said Vince Tibone, a retail analyst at Green Street.

Bank loans for commercial real estate hit a record high in the fourth quarter of 2022, but those lenders also set aside more money to cover potential losses from that financing amid recession fears, CoStar News reported. The sharp rise in commercial real estate lending creates the potential for wider profit margins, but also increases the risk of delinquencies if the economy tanks, Fitch Ratings said in a Jan. 31 report.

Almost 75 percent of workers polled in a London survey said they’d rather quit their jobs than return to the office full-time, with many saying they would need a pay raise of at least 16 percent to consider going back, according to Bloomberg data.