Did you hear about the office building in New York City purchased for $1 a few weeks back? Or the tower in Los Angeles that sold for HALF the amount it fetched just six years ago? Times are tough in the commercial real estate (CRE) industry – and signs of sunnier days on the horizon aren’t showing up.
Owners of facilities in major cities are hard-hit by vacancy rates of 20% or higher. Regional banks are weighed down by building loans coming due over the next year and a half. Federal Reserve Chairman Jerome Powell warned investors of multiple banks going under soon and hinted at no one coming to the rescue a la Silicon Valley Bank in March 2023.
The only ones benefitting from the turmoil in CRE are the lessees who are happy with their digs. Many are snagging good perks from landlords who want them to stay put. But enough businesses have fled that some cities are now feeling the heat. City lawmakers are taking steps to boost occupancy – and tax revenue – but the jury’s out on how those moves will pan out.
Let’s take a closer look at the state of the CRE market and where things stand for building owners, banks and cities:
Vacancy Catastrophe for Office Landlords
The national office vacancy rate rose from 19.6% in the 4th quarter of 2023 to 19.8% earlier this year, according to Moody’s. To put those numbers in perspective, the vacancy rate only hit as high as 19.3% twice, in 1986 and 1991, over the past 40 years until this current downturn.
But that’s not the really big CRE news to come from the global ratings guru: Moody’s expects office real estate value to plunge by 25% over the next 12 to 18 months.
As values drop and vacancies rise, building owners are doing all they can to attract and keep existing tenants. The savvy ones aim to keep listed rental prices as is to ward off vultures. Some sellers will go to extreme lengths to exaggerate the buy price of a property.
And the most desperate landlords are bending over backwards to satisfy tenants by:
- offering free months of rent
- waiving a security deposit
- paying for utilities, and
- fronting the money for facility upgrades and other amenities.
As of last fall, vacancy rates were hovering at 20% or were well above for some cities. The top 10 “ghost towns” are:
- San Francisco: 31%
- Los Angeles: 26%
- Chicago: 24%
- Phoenix: 24%
- Cleveland: 23%
- Denver: 22%
- Philadelphia: 19%
- Boston: 19%
- Houston: 19%, and
- Austin: 19%.
Regional Banks Face Greatest Risks
Well over half of CEOs and CFOs prefer to do business with smaller local banks or mid-size regional banks. A sizable percentage of these folks will be looking for new banking partners in the next couple of years and the distressed CRE market is the No. 1 reason.
Regional banks are in the unfortunate position of holding over two-thirds of CRE debt. Outstanding loans for CRE properties total $2.8 trillion. The lion’s share of those loans are coming due in 2025. Making matters worse, the Fed allowed a short-term loan program for banks holding CRE debts to expire this past March 11.
Some banks are rewriting loans — at higher rates of course — to give themselves and builders/owners more time. At least 15 regional institutions are overexposed when it comes to CRE loans — Valley National Bank, Valley National Bancorp, Flagstar Bank, New York Community Bank, Axos Bank, Washington Federal, WAFD, Axos Financial, Bank OZK, Umpqua, Columbia Banking System, Pacific Premier Bancorp, BCI Financial Group, Independent and City National Bank of Florida.
Cities Are Losing Critical Tax Dollars
Boston is one of a handful of sanctuary cities that are running out of money to provide normal city services, plus house and feed illegal aliens flocking in. The Boston Policy Institute predicts the city will lose $1.4 billion in tax revenue over the next five years due to companies moving out and whole floors of office buildings sitting vacant.
Boston Mayor Michelle Wu’s solution is to raise the business tax rate. “What we are trying to avoid here is a more sudden, dramatic and concentrated shock to residential property owners, which would hurt residents and businesses alike,” says Wu. The downside to Wu’s plan is business owners that don’t want to pay more and are in a position to move will pull up stakes.
Perhaps no city did a worse job of letting criminals and rioters get away with causing mayhem than Portland, Oregon. Rip City is struggling mightily to recover from the 2020 riots. The city council is now taking small steps to improve downtown, like exempting office-to-residential building conversions from paying city fees.
Of course, turning office buildings into apartment suites is expensive and takes time because of the amount of new plumbing that must be installed and other structural changes that are required. The smarter moves to lure businesses back to Portland would be putting criminals behind bars and lowering taxes.
Saint Louis is desperate to revive its moribund downtown where restaurants and stores closed their doors during the pandemic. “In a campaign to revive its office district, the city is trying to get more people on the streets,” reports the Wall Street Journal. “[The city] is adding landscaping, bike lanes and traffic barriers” and paying performers to play on street corners.
In the meantime, crooks are breaking into vacant buildings and stealing whatever they can find. Copper pipes and wiring are prime target for scavengers. Like most U.S. cities, police officers are retiring — early in some cases — and replacing them is an uphill battle.
