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The Next Crisis Will Start With Empty Office Buildings

https://msn.com/en-us/money/companies/the-next-crisis-will-start-with-empty-office-buildings/ar-AA1ceEKg?ocid=msedgdhp&pc=U531&cvid=606d641185224a20a6248989fb2c9e82&ei=10
Post-pandemic, kids are back in school, retirees are back on cruise ships, and physical stores are doing better than expected. But offices are struggling perhaps more than most casual observers realize, and the consequences for landlords, banks, municipal governments, and even individual portfolios will be far-reaching. In some cases, they will be catastrophic. But this crisis, like all crises, also represents an opportunity to reconsider many of our assumptions about work and cities.


During the first three months of 2023, U.S. office vacancy topped 20 percent for the first time in decades. In San Francisco, Dallas, and Houston, vacancy rates are as high as 25 percent. These figures understate the severity of the crisis because they only cover spaces that are no longer leased. Most office leases were signed before the pandemic and have yet to come up for renewal. Actual office use points to a further decrease in demand. Attendance in the 10 largest business districts is still below 50 percent of its pre-COVID level, as white-collar employees spend an estimated 28 percent of their workdays at home.


With a third of all office leases expiring by 2026, we can expect higher vacancies, significantly lower rents, or both. And while we wrestle with the effects of distributed work, artificial intelligence could drive office demand even lower. Some pundits point out that the most expensive offices are still doing okay and that others could be saved by introducing new amenities and services. But landlords can’t very well lease all empty retail stores to Louis Vuitton and Apple. There’s simply not enough demand for such space, and new features make buildings even more expensive to build and operate.

With such grim prospects, some landlords are threatening to “give the keys back to the bank.” Over the past few months, the property giants RXR, Columbia Property Trust, Brookfield Asset Management, and others have collectively defaulted on billions in commercial-property loans. Such defaults are partly an indication of real struggles and partly a game of chicken. Most commercial loans were issued before the pandemic, when offices were full and interest rates were low.

The current landscape is drastically different: high vacancy rates, doubled interest rates, and nearly $1.5 trillion in loans due for repayment by 2025. By defaulting now, landlords leverage their remaining influence to advocate for loan extensions or a bailout. As John Maynard Keynes observed, when you owe your banker $1,000, you are at his mercy, but when you owe him $1 million, “the position is reversed.”
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Comments

  • funny did not explain how this turns into a "crisis".
  • Banks have many reasons to worry. Rising interest rates have devalued other assets on their balance sheets, especially government bonds, leaving them vulnerable to bank runs. In recent months, Silicon Valley Bank, First Republic, and Signature all collapsed. Regional institutions like these account for nearly 70 percent of all commercial-property bank loans. Pushing down the valuation of office buildings or taking possession of foreclosed properties would further weaken their balance sheets.

    Municipal governments have even more to worry about. Property taxes underpin city budgets. In New York City, such taxes generate approximately 40 percent of revenue. Commercial property—mostly offices—contributes about 40 percent of these taxes, or 16 percent of the city’s total tax revenue. In San Francisco, property taxes contribute a lower share, but offices and retail appear to be in an even worse state.

    Empty offices also contribute to lower retail sales and public-transport usage. In New York City, weekday subway trips are 65 percent of their 2019 level—though they’re trending up—and public-transport revenue has declined by $2.4 billion. Meanwhile, more than 40,000 retail-sector jobs lost since 2019 have yet to return. A recent study by an NYU professor named Arpit Gupta and others estimate a 6.5 percent “fiscal hole” in the city’s budget due to declining office and retail valuations. Such a hole “would need to be plugged by raising tax rates or cutting government spending.”
  • what constitutes a crisis? so far with all the empty buildings, we have not entered recession and Unemployment rate is under 4%.
  • @operation_twist: Instead of trying to pick apart the excerpts that Lewis has posted why not try using the provided link, reading the entire report and figure things out for yourself?
  • @operation_twist The headline is "The Next Crisis Will...," not "The Current Crisis Is..."
  • edited June 2023
    One possibility, I'm not sure how feasible, is to convert office space to manufacturing space. I've been reading there is a manufacturing building boom going on so it may not be as bad as perceived if in fact that can be accomplished. It'll also bring people who work there back to the city/wherever to help local businesses.
  • Most manufacturing operations are single-story ground-level buildings, because of the need for easy logistics shipping and delivery, the efficient layout of the manufacturing assembly process, and ease of installation and maintenance of production equipment.

    Office space in large buildings is typically multi-story, with limited areas for logistics, and elevators which are not designed for heavy equipment transportation.

    These types of buildings are also very difficult to economically convert to housing space.
  • @Old_Joe ; You're right on. How about getting the homeless off the street.
  • edited June 2023
    @Derf- Now, that's an interesting thought. But I don't imagine that it would work unless the entire building was available. I can't see any remaining office workers looking forward to sharing the elevators.

    H'mm- has possibilities.
  • Converting these office space into other uses will not be trivial and most likely it will be costly. It is out of question for heavy manufacturing. Light manufacturing and living are possible depending on the building codes and lots of remodeling.

    Low occupancy rate of these high value properties affect everyone like a domino effect. It needs to be solve somehow.
  • The problem is that these "high value" properties are only high value if they have tenants. As they empty the value steadily decreases, until no one wants to commit any additional funding to remodel them.

    They are, primarily, "built-to-purpose" structures, and do not integrally have the necessary utilities installed which would be capable of quick subdivision into living facilities.
  • beebee
    edited June 2023
    Often cities agree to provide these companies with tax abatements in hopes that the multiplier effect will provide a win-win for everyone.

    In these scenarios, risk is squarely on the cities, not on the soon to be evicted company.

    tax-breaks-cities-affluent
  • @Old_Joe I think some of the hotels that were mentioned in a post of yours could be converted at a "low" cost. But as you mentioned who's your neighbor going to be !?
  • @Derf- For a couple of years during the pandemic SF leased a number of smaller hotels- decent buildings- to use as temporary housing for a number of the street people. When the leases were up, the hotels were found to have been largely trashed. Now the taxpayers are on the hook to fix that, too.
  • Tax-incremental-financing (TIFs) only waves future incremental tax revenues for a while (20-30 years) and there is no immediate money commitment from the local government. So, the current "low" taxes on that property continue now, and for the future, until the TIF period expires (and taxes jump to the new property assessment level). Real cost to the local government is higher level of city services it has to provide on the new property if it comes to fruition (many such projects are delayed or fall through, and then the local government doesn't lose anything except face).

    If in addition, the local government issues bonds (munis), to be supported by the future property revenues, then it on the hook to the extent spelled out in the bond issue. Those holding munis know these as AMT munis.

    However, there is multiplier effect with the TIFs because private funding becomes more easily available, and some federal funding can also be tapped.

    I think TIFs are great.

    https://en.wikipedia.org/wiki/Tax_increment_financing
  • Old_Joe said , "For a couple of years during the pandemic SF leased a number of smaller hotels- decent buildings- to use as temporary housing for a number of the street people. When the leases were up, the hotels were found to have been largely trashed. Now the taxpayers are on the hook to fix that, too."
    I don't doubt that one bit !!
    @yogibearbull : Are you suggesting the city use TIF to convert the hotels to living quarters ?
    Heck, hire a doorman & desk clerk & let the homeless in !
    Just joking, Derf
  • I know of a city that converted a downtown hotel into an assisted living facility. Residents loved the assistance and proximity to downtown shops and restaurants. It is now converted back to a hotel and I don't know why.
  • @Anna- Sad experience has shown that there are definitely two distinct types of homeless- some are just ordinary people who have been dealt a really lousy hand and fallen on evil times. These people can respond to and benefit from a helping hand to get them back into a decent situation.

    The majority though, at least here in SF, are druggies and crazies who respond to nothing other than their next high.
  • edited June 2023
    @Old_Joe The homeless situation in SF is more complex and the hotel program was more successful than you're acknowledging: https://sfexaminer.com/news/politics/pandemic-shelters-may-set-path-for-sf-homeless-response/article_b956bd42-da44-11ed-b04b-7f692881f8fd.html
  • @LewisBraham- Sorry, but I have to disagree on this one- the Examiner article refers to an individual as I described above in reply to Anna: an ordinary person who has fallen on really bad times. There are in fact a number of organizations here in SF who do really excellent work in helping out in those types of situations, and my wife and I have substantially supported them for many years.

    To repeat- the majority though, at least here in SF, are druggies, thieves and crazies who respond to nothing other than their next high. A number of the hotels described in the Examiner article were substantially trashed during the pandemic temporary housing program- something that the Examiner chose not to report.

    A short excerpt from a pertinent report in the San Francisco Chronicle:

    Hotels are seeking millions from S.F. for damage when they were homeless shelters.

    Hotel Union Square’s cleanup bill was steep — $5.6 million to repair rampant smoke damage, broken light fixtures, mold and other problems.

    As city supervisors consider shelling out millions to settle the dispute over damages at one of San Francisco’s hotel homeless shelters, taxpayers could be on the hook for millions more to settle similar claims from other hotels that participated in the program.

    In September 2021, the owners of Hotel Union Square filed a claim with the city, alleging unhoused residents who the city had placed there had caused $5.6 million in damages — and cost the Dallas-based hotel operator hundreds of thousands more in lost rent.

    City officials created the Hotel Program in 2020 during the COVID-19 pandemic and used it to house more than 3,700 high-risk residents in 25 hotels. With federal and state funding drying up, the city has gradually closed most of the hotels.
  • @Old_Joe Sorry, I guess I didn't explain. This was an assisted living facility as in a place where elderly middle-class people pay for small apartments and assistance with meals and daily living, if needed. I wasn't speaking of assistance to the needy.
  • @Anna : Is it possible that building didn't meet code requirements for assisted living ?
  • The Examiner article mentions the suits, but also mentions the success rate for finding people permanent housing instead of them ending up back on the streets was much higher:
    In December 2022, the final month of the program, after getting to a better than 70% success rate placing people into housing throughout the rest of 2022, only half of the people being served by the program ended up in housing. They were instead offered temporary shelter and remain in the “housing location process,” according to HSH, which has promised to track their progress through this June.

    HSH spokesperson Emily Cohen attributes this decline in success as a natural consequence of the those that remained as the hotels had closed. If they were still at the hotel by that point, there was a good chance the person staying at the hotel had already declined an offer of housing or faced some other barrier to obtaining housing, she said.

    Taken as a whole, the SIP Hotel Program had a success rate that Cohen claims is “very good” compared to the average of 20% of all people experiencing homelessness who are, in normal circumstances, prioritized for and placed into permanent housing.
  • edited June 2023
    Derf said:

    @Anna : Is it possible that building didn't meet code requirements for assisted living ?

    No there was no problem that I know of. I knew someone whose relative lived in assisted living there for years. She finally died and I lost track of what happened after that. It was an old landmark hotel. At this time it has been modernized and converted back to a hotel. So whoever ran the assisted living facility must have sold it.
  • Anna said:

    @Old_Joe Sorry, I guess I didn't explain. This was an assisted living facility as in a place where elderly middle-class people pay for small apartments and assistance with meals and daily living, if needed. I wasn't speaking of assistance to the needy.

    I'm guessing this happened in a city with a better downtown situation than many. Somebody wanted the building to make more money with, and got it.

    Sequi pecuniam. Or, as they said in the old days cui bono?
  • edited June 2023
    My Latin is nonexistent- thank goodness for DuckDuckGo.
  • Old_Joe said:

    My Latin is nonexistent- thank goodness for DuckDuckGo.

    All kinds of fun ain't it?

    Almost everything sounds better in Latin.

    And I use duckduckgo for most searches now.
  • Barron's this week has a positive Cover story and a positive Q&A on real estate. Suggestion is to start bottom fishing cautiously. Sure, there are concerns and lots of bad news, but when everything is hunky-dory, prices would have moved up already.
  • edited July 2023

    Barron's this week has a positive Cover story and a positive Q&A on real estate. Suggestion is to start bottom fishing cautiously. Sure, there are concerns and lots of bad news, but when everything is hunky-dory, prices would have moved up already.

    +1. Could not agree more. As Barron’s pointed out, ex office buildings the commercial real estate market is in good shape. One of the few open end bond plays in CRE is RCRIX which I have previously mentioned. It is on track for a double digit year up 5.49% YTD. It holds nothing in office buildings. The manager makes a compelling case for double digit returns both this year and next. I have a few issues with this fund however.

    Another bond fund which I am intimately acquainted with has 13% in commercial real estate and it is up around 7% YTD. It has been a sneaky good year for some areas in Bondland. Many still seem to be underinvested in bonds. Either scarred by last year’s bond bear market or fearful of continuing tightening by the Fed. The 5% yield of many money market funds is another reason investors have no urge to venture into the riskier areas of Bondland.

  • @operation_twist The headline is "The Next Crisis Will...," not "The Current Crisis Is..."

    +1.
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