NOTICE TO READERS: As Trends Journal subscribers well know, when the COVID War was officially launched in the United States by President Donald Trump on 13 March 2020, Black Friday, and people were forced to work from home, we had forecast an Office Building Bust.
While it was ignored by the mainstream media for some three years, and despite our sending out tens of thousands of press releases forecasting this trend, it is now finally making the mainstream press. As the following articles detail, they are just now assessing the damage ahead.
COMMERCIAL REAL ESTATE VALUES WILL CRASH IN KEY U.S. CITIES BY 2025
Over the next 18 months, commercial real estate values will plunge by as much as 40 percent in Boston, Chicago, Los Angeles, New York City, San Francisco, and Washington DC, according to a new forecast from Capital Economics.
Western cities including Denver, Portland, and Seattle will see comparable declines, the prediction said.
Office vacancies in those six key urban centers will average 19 percent by the end of next year, the prediction said.
San Francisco will suffer most, with values plummeting by 40 to 45 percent. Values in Chicago and New York will fall 30 to 35 percent. Los Angeles and Washington will see market values drop 25 to 30 percent and commercial properties in Boston will decline by 25 percent.
In southern cities such as Atlanta, Dallas, and Miami, declines will be 20 percent at most.
Morgan Stanley analysts see a similar crash in commercial property values over the same time period, meaning that the sector would suffer a worse decline than during the Great Recession in 2008.
TREND FORECAST: A 40-percent crash in commercial real estate values will tee up these six cities for a death spiral: lower property values means the cities will see property tax revenues crash.
With cities depending on property taxes for a significant share of their budget—often half or more—in the short term cities will have to deal with the loss by cutting services, which will lower the quality of life for their residents.
That will drive more residents out, driving down residential property values as well as those for commercial buildings, straining cities’ budgets even more as the death spiral deepens.
REMOTE WORK BITES OFFICE BUILDINGS’ SECONDARY ECONOMY
The office building bust continues to ripple through related business sectors.
First, it wiped out broad swaths of downtown retail and service businesses as the commuter workforce has shrunk by half in major cities, as we have reported in our Top 2023 Trend, Office Building Bust, as well as in a series of articles including:
We have documented this evolving trend in a series of articles, including:
- “Commercial Real Estate in a Tailspin” (20 Oct 2020)
- “Deloitte Abandons More London Office Space” (26 Apr 2022)
- “GM Softens Back-to-the-Office Requirement After Worker Backlash”(4 Oct 2022)
- “New York City’s Workforce Sharply Shrinking” (24 Jan 2023)
- “Office Occupancy Half of What It Used to Be” (7 Feb 2023)
- “Study: One Billion Square Feet of U.S. Office Space Will Be Empty by 2030” (28 Feb 2023)
Next, the bust collided with city governments as office property owners began protesting tax valuations of their office buildings, as we reported in “As Forecast: Business Office Bust Begins to Bite” (20 Dec 2022).
Landlords want their tax bills to reflect their plunging property values, which would sharply lower property tax revenues for municipal governments.
Now the bust is damaging secondary businesses that depend on a thriving office economy: architects, cleaning services, furniture stores, real estate brokers, and similar enterprises that make offices ready for use.
This secondary office economy employed tens of thousands and earned tens of billions of dollars annually by servicing thriving central offices, The Wall Street Journal said.
Now, like downtown retailers, those jobs and businesses are shrinking or disappearing.
Most are small businesses. About 30 percent of architecture firms feeling the pinch are sole practitioners and 60 percent have no more than five employees.
Henegan Construction in New York City had specialized in office interiors. It has laid off 50 people. SanMar Building Services used to clean 30 office buildings a night; now the number is 15.
Steelcase, the office furniture giant, reported revenue of $751.9 million in its most recent quarter, compared to $824.3 million for the same period in 2019.
Office construction’s value will be about $82.2 billion this year, data service Dodge Construction Network has predicted; it was $138.8 billion in 2019.
The construction industry is lucky: because other sectors are growing, such as healthcare, jobs in building number 7.9 million this year against 7.5 million in 2019.
Investors bought $17.6 billion worth of office buildings in the first five months of this year, two-thirds less than the same period last year, MSCI Real Assets reported. New searches for available office space this year have been 37 percent fewer than in 2018 or 2019, data service VTS said.
That plunge in sales and searches has slashed the income of lenders and brokers who depended on office buildings for a significant share of their incomes.
CBRE Group, the world’s leading real estate services firm, announced a $400-million initiative last year to cut costs, including layoffs. Eastdill Secured, a global real estate investment bank, has dumped 7 percent of its staff.
Pre-COVID, tenants signed ten-year office leases and brokers’ commissions amounted to about a third of the first year’s rent, Jim Wacht, head of the New York office of brokerage firm Lee & Associates, told the WSJ.
Now leases average three years and commissions are about 12 percent of the first year’s payments.
TRENDPOST: One of the largest sectors damaged by the office building bust is banking.
Small and regional banks hold more than 60 percent of commercial property loans. Through 2025, an estimated $145 trillion in commercial real estate loans will come due, many of which will need to be renegotiated.
TREND FORECAST: Higher costs and the need to offer free months and other perks to keep tenants and attract new ones have squeezed landlords’ margins. Many will be unable to pay off their loans, much less renegotiate them at vastly higher interest rates.
HSBC is among banks that already are selling their commercial real estate loans at a discount to get them off the books before they go bad.
Ultimately, the commercial real estate bust will force more banks to sell themselves to competitors to avoid failure. However, more bank failures are not out of the question. In fact, we are headed for the worst banking crisis in modern history since this Office Building Bust is global.
REMOTE WORK IS SPREADING THROUGH THE ECONOMY
Fifty-one percent of U.S. companies have instituted some kind of hybrid work policy, according to a survey by data service Scoop of 4,000 businesses.
Thirty percent of companies have a “structured hybrid work policy,” which requires employees to be in the office a fixed number of days each week. The number was just 20 percent in this year’s first quarter.
The proportion of businesses with free-form arrangements that let workers decide when, if ever, to come to a central office declined from 31 percent to 28 percent in the second quarter from the first.
White-collar workers led the transition to remote work but other job sectors—including less-educated employees and lower-paid service workers, such as customer service contacts and freight dispatchers—also are now clocking more time from home than before the COVID War, according to The Wall Street Journal.
Across the U.S. workforce, employees averaged five hours and 25 minutes a day working remotely in 2022. That was just 12 minutes fewer than in 2021 but two hours more than in 2019, the U.S. labor department reported.
The lowest-earning workers, including those without a high-school diploma, spent roughly three more hours working remotely last year than in 2019. The highest earners still work remotely about 45 minutes more per day than the lowest earners.
The spread of remote work to more jobs resulted from employers discovering that lower-paid employees were equally or more productive at home than at a central location, the WSJ noted.
Those productivity gains led to fewer absences, fewer workers quitting, and allowed businesses to operate with less office space, cutting overhead costs. Employers realized they were onto a good thing and let workers stay home even after the COVID lockdowns ended.
In June, the 12-month average of customer service jobs offering remote work listed with ZipRecruiter was 22 percent, up from 18 percent in 2019 but down from 33 percent from February 2022, the WSJ said. In 2022, 4.9 percent of health care jobs listed offered remote or hybrid work options, compared to 1.8 percent in 2019.
On 31 May, about 8.4 percent of jobs advertised on Indeed.com offered remote or hybrid work. While triple the number at the same time in 2019, the figure has slipped from a peak of 10 percent in February 2022.
TRENDPOST: The figures show that workers have used their clout to normalize remote work.
However, many still realize the value, if not the necessity, to be in the office at least some of the time. Employees and their bosses are finding an equilibrium that meets the needs of both. As a result, remote work is no longer a bone of contention in most offices.
TREND FORECAST: Workers won the battle over remote work. That victory has awakened them to their power. In the future, workers will be much more ready to push demands for greater benefits and other perks.
OFFICE BUILDING BUST ROILS NEW YORK’S GROUND-RENT NEGOTIATIONS
In New York City, companies owning buildings often do not own the land on which the buildings sit. Instead, building owners lease the land through decades-long contracts.
Typically, the cost of renting ground fluctuates with the value of the buildings resting on it.
Since the COVID War, the value of retail and office space in the city has fallen as much as 20 percent or more.
“If I’m a ground-lease tenant, right now is probably a good time to be doing a rent re-set,” Joshua Stein, a real estate attorney in the city, told The Wall Street Journal.
That is not an easy thing to do. Renegotiating ground rents often are contentious.
Also, the value of land traditionally is partly determined by the value of nearby buildings. However, in this year’s first three months, investors bought only $489.5 million worth of New York’s office towers, less than a tenth of the $5 billion they put in during 2022’s first quarter, MSCI Real Assets reported.
As a result, an acre of land in the city’s office district sold for $67.7 million this year, 57 percent below last year’s average price, according to data service CoStar. In 2019, the average was a record $278 million.
That has shocked landowners, many of which are not yet ready to accede to building owners’ demands to slash ground rents.
Vornado Realty Trust has been negotiating a 50-year lease for the land under its Penn 1 office building, which it recently spent $450 million renovating. Earlier this year, the company expected its rent could rise from the current $2.5 million annually to as much as $25 million by 2073.
“We now think that number should be quite a bit lower,” Vornado chair Steve Roth recently told investors.
Ground-rent deals are now shifting to be based more on the rate of inflation than on surrounding property values.
For example, Safehold, which owns 15 ground leases in the city, is now raising rents by a fixed 2 percent each year and adjusts rents according to inflation once each decade.
The arrangement “is much more manageable for the tenant and the owner has a pretty predictable cash flow stream,” Richard Kessler, COO of Benenson Capital Partners, which also owns ground leases in New York and elsewhere, told the WSJ.
TREND FORECAST: As Trends Journal subscribers well know, we had long forecast the Office Building Bust and its implications which are just now being reported in the mainstream media.
- “THE NEW LIFE OF LOCKDOWN” (19 May 2020)
- “REMOTE WORK = COMMERCIAL BUST” (2 Jun 2020)
- “SLIDING VALUE OF OFFICE SPACE HITS URBAN CENTERS” (11 Aug 2020)
- “WORK FROM HOME, CITY REAL ESTATE DOWN” (20 Oct 2020)
- “COMMERCIAL REAL ESTATE IN A TAILSPIN” (20 Oct 2020)
- “OFFICE WORKERS STAY HOME” (8 Dec 2020)
- “RETURN TO OFFICES POSTPONED: COMMERCIAL REAL ESTATE BUST?” (14 Sep 2021)
- “WORKERS STAYING HOME, COMMERCIAL REAL ESTATE DISASTER LOOMING” (19 Oct 2021)
- “COVID WAR KEEPING WORKERS OUT OF THE OFFICE” (16 Nov 2021)
- “NYC BUSINESSES: BYE, BYE NYC” (16 Nov 2021)
- “DELOITTE ABANDONS MORE LONDON OFFICE SPACE” (26 Apr 2022)
- “GM SOFTENS BACK-TO-THE-OFFICE REQUIREMENT AFTER WORKER BACKLASH” (4 Oct 2022)
- “BUSINESS OFFICE BUST BEGINS TO BITE” (20 Dec 2022)
- “NEW YORK CITY’S WORKFORCE SHARPLY SHRINKING” (24 Jan 2023)
- “OFFICE OCCUPANCY HALF OF WHAT IT USED TO BE” (7 Feb 2023)
- “TOP TREND 2023, OFFICE BUILDING BUST: INVESTORS BACK AWAY FROM DOWNTOWN PROJECTS” (27 Jun 2023)
- “TOP TREND 2023: OFFICE BUILDING BUST, HSBC LATEST TO FLEE LONDON’S CANARY WHARF” (5 Jul 2023)
- “TOP TREND 2023, OFFICE BUILDING BUST: OREGON’S LARGEST CITY LOSING POPULATION” (5 Jul 2023)
WHY SO FEW EMPTY OFFICES WILL BE CONVERTED TO APARTMENTS
Seems simple: cities lack affordable housing. Homeless people camp on the streets. Cities also have a growing number of empty office buildings. Ergo, convert offices to apartments. Problem solved.
Not so simple: several obstacles block the path from office building to apartment block.
Financier Joey Chilelli explained why in a recent edition of Bloomberg’s “Odd Lots” podcast covering investing.
Chilelli knows whereof he speaks. He’s managing director of the Vanbarton Group, an investment firm that has backed the conversion of one New York office block to apartments and is involved in another.
First, zoning ordinances define what kinds of uses a building can be put to. Winning a variance, allowing a change of use, can be time-consuming and require a series of hearings, assurances, and forms to file.
Also, in New York City, buildings are eligible for conversion only if they were built before a certain date—and that date varies from neighborhood to neighborhood.
The reason is to ensure that new housing is supported by the existing infrastructure of schools, transportation, and other services. However, the dates prevent developers from considering potential conversions.
Other cities have similar quirky restrictions.
Second, office towers and apartment buildings are designed differently. Older office buildings may let in relatively little daylight. Plumbing often is centralized in a vertical column through an office block. Air circulation in a floor of offices is vastly different from the same consideration in a floor of flats.
“You’re carving out the residences, but you’re also reinforcing the structure with more steel,” Chilelli said. “You have to make sure that plumbing risers or duct work or electrical risers miss that steel. You also have to have certain dimensions that are held within the apartment itself for code. Putting all those together is like one big puzzle”—a puzzle not all developers are willing to try to solve.
“Finding the experts is difficult, and it takes years to create that team that you’re comfortable with and know that everything is going to go as planned,” he added.
Third, repurposing a building can be more expensive than constructing a new one from scratch, especially at a time when both costs and interest rates are rising.
If a developer pays $500 a square foot to buy the building and is looking at another $500 a square foot to convert it to living space, “you’re looking at $1,000 a foot,” Chilelli said. “That’s a pretty hefty price today.”
That means that conversions need to charge high rent, which puts them beyond the reach of people in need of affordable housing.
Since high costs require high rents to offset, most office conversions tend to cater to the luxury segment of the market, which means they have historically done little to alleviate a shortage of affordable housing in the city.
New York’s legislature may help steer conversions in a more affordable direction; it now is considering offering property tax exemptions for landlords who make room for below-market-price housing if they redevelop offices into flats.
TREND FORECAST: If any significant number of unused office buildings are going to be converted to affordable housing, it will be because either cities have taken ownership and are willing to fund the work; or because state housing agencies take a hand in paying the hefty cost.
And as we have been reporting, there are numerous reasons why it is difficult to turn empty office buildings into apartments:
- “AS FORECAST: BUSINESS OFFICE BUST BEGINS TO BITE” (20 Dec 2022)
- “PLAN TO TURN NEW YORK’S VACANT HOTELS TO HOUSING NOT WORKING” (5 Apr 2022)
- “WALL STREET, DEAD STREET, OFFICE BUILDINGS GOING CONDO” (28 Jun 2022)
- “SPOTLIGHT, TOP TREND 2023: OFFICE BUILDING BUST” (28 Apr 2023)
- “SPOTLIGHT: OFFICE BUILDING BUST” (25 Apr 2023)
- “TOP TREND 2023: OFFICE BUILDING BUST” (15 Jun 2023)
- “TOP TREND 2023, OFFICE BUILDING BUST: INVESTORS BACK AWAY FROM DOWNTOWN PROJECTS” (27 Jun 2023)