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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.”
© 2015 Mutual Fund Observer. All rights reserved.
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Comments
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.
H'mm- has possibilities.
Low occupancy rate of these high value properties affect everyone like a domino effect. It needs to be solve somehow.
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.
In these scenarios, risk is squarely on the cities, not on the soon to be evicted company.
tax-breaks-cities-affluent
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
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
The majority though, at least here in SF, are druggies and crazies who respond to nothing other than their next high.
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:
Sequi pecuniam. Or, as they said in the old days cui bono?
Almost everything sounds better in Latin.
And I use duckduckgo for most searches now.
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.