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Already losing tenants due to remote work, owners of office buildings find themselves pinched by rising interest rates and tenants’ fears of recession that could lead to layoffs and even more space reductions.

Vacancy rates in many traditional business hubs such as Chicago, New York, and San Francisco reached record high levels over the past two years.

The last three recessions all sparked a rise in office vacancies, Moody’s Analytics said.

Share prices of publicly-traded office landlord firms lost 29 percent during this year’s first quarter, more than the 21 percent the Standard & Poor’s 500 index gave up over the period, The Wall Street Journal noted.

Landlords were hoping for a stronger second half of the year in 2022 as employers demanded their workers return to central locations, the WSJ said. 

However, employees are using their leverage in a tight labor market to negotiate hybrid or fully remote work arrangements, dashing landlords’ hopes of rising demand for their spaces.

Still, the number of delinquent mortgages on office properties remains low, in part because landlords are carrying less debt than they did entering the Great Recession in 2008, the WSJ reported.

However, if climbing interest rates spark a recession and a greater number of corporate defaults, vacancy rates could spike even higher, the WSJ warned.

The market value of office properties already has slumped 8 percent so far this year, according to real estate data firm Green Street.

The outlook is causing potential buyers to cancel deals. Investor Harbor Associates agreed in May to pay $165 million for Union Bank Plaza in Los Angeles but backed out less than a month later, even though the agreed price was $40 million less than the current owner paid in 2010.

Sunbelt landlords have a sunnier outlook: during the COVID War, people and companies flocked south, boosting demand for office space, as we report in Red States Fared Better Than Blue Ones in the COVID Era in this issue.

PUBLISHER’S NOTE: As the COVID War was just beginning, we predicted in “Real Estate Dead? Time to Buy?” (14 Apr 2020) “a long and steady downhill slide” in commercial property values.

We were correct, with vast numbers of office buildings and shopping malls becoming albatross properties unlikely to survive in their present forms.

TREND FORECAST: The real estate and financial industries, along with municipal governments, are struggling to figure out what to do with office buildings that are largely empty or with downtowns seeing a fraction of their past commuting workforce.

Landlords are stuck in the middle. We reported in our “Real Estate Industry Update” of 13 April, 2021, that Fitch Ratings has calculated that allowing the nation’s office workers to spend a day and a half at home each week would reduce office space needs enough to cut landlords’ profits 15 percent; three days a week would slash 30 percent from profits, Fitch said.

A move to transform empty commercial towers into apartment blocks has run into trouble, as we detailed in “New York’s Plan to Turn Empty Hotels to Housing Not Working” (5 Apr 2022). Office buildings have centralized plumbing, little soundproofing, windows that are sealed shut, and are not designed to allow natural light into all corners.

Zoning regulations also often stand in the way of any such change.

That leaves many downtowns’ commuter-dependent retail and services sectors bereft of customers. Most businesses that died during the COVID shutdown will either stay dead or return in some other form—perhaps sharing space with other retailers or open only limited hours.

Municipalities lie under the wreckage. Property taxes make up half or more of most cities’ revenue and taxes are based on property values. Empty storefronts and less-valuable office towers shrink the tax bases cities need to pay for services—and fewer services make a city a less-desirable place to live, driving residents out (as happened during the COVID War) and reducing revenues even further in a downward spiral.

In an effort to pay their bills and salvage their investments, some creative office landlords will offer empty offices to yoga studios, massage clinics, coffee-and-book shops, and other retailers—perhaps even satellite campuses for colleges—to create a new ecosystem for tenants that would allow them richer workday and after-work lives without having to leave their buildings.

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