If you missed this story last week, the summary is that there are some real estate experts who believe the pandemic may have created a new normal, one that has major implications for our cities. I can summarize this in three steps.
First, when the pandemic hit, there were lots of white collar workers who decided to leave the city and ride out the storm in their 2nd homes in the Hamptons or Vermont or wherever they could go that was away from lots of other people. On top of this, you had the lockdowns which forced many corporations to be extremely flexible with remote work and Zoom meetings in order to survive. And it turns out many employees preferred working from home, at least a few days a week. Now that the Zoom genie is out of the bottle some employees don’t want to go back to 5 days a week in the office. In fact, some employees have left the city behind and taken advantage of much better home prices in the suburbs just because they aren’t expected to be there everyday.
Work from home turns out to benefit big companies too because it allows them to economize on real estate, potentially saving them a lot of money every year. We likely haven’t seen the full impact of this yet because commercial real estate leases often run for multiple years, meaning many companies are still locked in to their old agreements for now.
Second, removing all of those workers from downtown has an impact on other businesses which were dependent on them, i.e. restaurants, shops, etc. that catered to officer workers. Many of those shops and restaurants are struggling to survive or have already closed which also means there is not as much to draw people from the suburbs into the cities at night or on the weekends. In many places there were hopes that after the pandemic ended people would return to downtown but it’s not happening in many cities, at least not quickly.
Finally, the third part of the doom loop comes from the impact that less economic activity downtown has on the cities themselves. Much of their revenue comes from these areas so if they aren’t being utilized the city’s tax base is shrinking and that means fewer resources to deal with problems (homelessness, crime) that are also plaguing cities. So hopefully you can see how all of this creates a loop that feeds back on itself. The less money cities have, the less appealing downtown areas are. The less appealing those areas are, the less chance of luring customers and businesses back to downtown.
Over the weekend, David sent me this story which seems to fit right in with the whole “urban doom loop” scenario. This one is about Minneapolis-St. Paul:
Owners of some of the most expensive office towers in the Twin Cities are choosing to walk away from their properties instead of continuing to make loan payments.
Nearby Fifth Street Towers is facing the same fate and may also go back to its lender this month, according to Axios’ sources who were not authorized to discuss the matter.
Real estate experts predict more distressed office properties will follow suit, in Minneapolis, St. Paul and the suburbs.
And the outcome of all these distressed properties is likely to be lower rents to combat vacancy and therefore a shrinking tax base. Looking around, there are lots of stories like this. This story is about Washington DC:
Foot traffic in D.C.’s downtown and Golden Triangle areas is better than it was in 2020 but it’s still far below pre-pandemic levels. City officials are now looking for ways to bring customers back to struggling retail businesses that depended heavily on office workers.
About one fifth of offices in the Central Business District in D.C. are vacant at the moment. That’s nearly double the 2019 level according to the nonprofit, Federal City Council…
The group sent a letter to the city’s Chief Financial Officer, Glen Lee, last week. In part, it read: “The pandemic and work from home have further eroded fundamentals and all indicators of the health of the District’s office market point increased systemic risk and distress.”
Here’s one about Salesforce, the largest private employer in San Francisco:
The city’s largest private employer could continue to downsize its office footprint, executives said in a recent earnings call.
Salesforce CEO Marc Benioff said there will continue to be flexibility for employees who want to work from home, while Chief Financial Officer Amy Weaver said the software company is continuing to evaluate its real estate holdings. Salesforce did not respond to a request for comment as of publication.
“Over the past two years, we have continued to re-imagine our real estate strategy,” Weaver said on the call. “That is not only to optimize for scale but also continue hybrid work environment and how people are working and how they’re using their space. And this has included reducing our footprint fairly significant right now.”
Finally, in New York there has been some improvement lately but high interest rates are still expected to lead to distressed real estate sales in the next few months.
The world’s largest office market has of late endured the departure of big-spending Chinese investors, the rise of Covid-era remote working and the economic fallout from the Ukraine war. Now there is mounting concern that the dramatic rise in interest rates will be too much for many owners to sustain and that a long-awaited reckoning is drawing near.
“There’s a consensus feeling that capitulation is coming,” said Harmon, who likened rising rates to petrol igniting an office firestorm. “Everywhere I go, anywhere around the world now, anyone who owns office says: ‘I’d like to lighten my load.’”
The industry is rife with talk of partnerships breaking up under duress, office buildings being converted for other uses and speculation about which developers may not make it to the other side. Meanwhile, opportunists are preparing for what they believe will be a bevy of distressed sales at knockdown prices, perhaps in the first quarter of the next year.
“We’re going to see distress,” said Adelaide Polsinelli, a veteran broker at Compass. “We’re seeing it already.”
If you’re looking for a more optimistic take on all of this, JP Morgan Chase put out a Commercial Real Estate Outlook assessment last week. It’s upbeat if a bit vague.
The future of office buildings remains up in the air. It is, however, important to note that none of the regions across the U.S. have seen vacancy rates dip below their pre-pandemic Q4 2019 levels, according to Moody’s Analytics.
In some cases, the right location with the right amenities—think optimizing floorplans for collaboration, offering private outdoor space and adding onsite services such as childcare and catering—may bring employees back to the office.
“Looking ahead, we are not in the ‘office is dead’ camp, but we think cash flow growth will be challenged in the office sector,” said Anthony Paolone, Senior Analyst and Co-Head of U.S. Real Estate Stock Research at JPMorgan Chase.
So maybe the outcome won’t be doom but it will probably be rough in the short term, especially if interest rates keep rising and the country lands in a recession as many economists now believe it will.