Looks like interesting times ahead for city business districts

 

The "work-from-home" (whether you want to or not) push that resulted from the COVID-19 epidemic is having very nasty consequences for investors in commercial properties in city business districts.

Cantor Fitzgerald CEO Howard Lutnick spoke with Fox Business host Maria Bartiromo on the sidelines at the World Economic Forum in Davos, Switzerland, last week. He offered a bleak outlook on the commercial real estate sector, warning a "very ugly" two years is ahead. 

"Coming due in the next two and a half years at these higher rates - you're not going to get proceeds, meaning when you have a $120 million loan on a building, and someone says I'll give you 90 million at a much higher rate - than it throws the keys back to the lenders - and there's going to be a lot of them that are going to get wiped out," Lutnick told Bartiromo.

"I think $700 billion could default … The lenders are going to have to do things with them. They're going to be selling. It's going to be a generational change in real estate coming at the end of 2024 and all of 2025. We will be talking about real estate being just a massive change," Lutnick said.

He warned: "I think it's going to be a very, very ugly market in owning real estate over the next, you know, 18 months, two years."

There's more at the link.

True dat.  Interest rates are much higher today than they were even three or four years ago.  A mortgage at, say, 2% that's due to be renegotiated may end up costing the borrower 5% or 6% - and that's if his credit rating is extraordinarily good.  The additional cost of the higher interest rate may make his entire property uneconomical, because he can't charge enough in rent to cover it.

His customers won't care.  When companies realize that they can cut back their central office space by having people work from home, and can save millions (even billions) in the process, they're going to take that win.  Unfortunately, those who build the office blocks and other structures they previously used are going to be the losers.  When they can't rent out enough of their building space, they can't make enough in rent to afford mortgage payments, insurance premiums, city taxes, and so on . . . so they're stuck with a white elephant.  They can't sell it for what it cost them, either, because nobody will pay those old-fashioned inflated prices when they can't earn a sufficient return on their investment to cover them.  Already a number of owners of commercial properties have literally abandoned them to their mortgage holders, walking away from them because it's no longer economical to keep them running.

Unfortunately, it's not just building owners who face disaster.  There are all sorts of ancillary structures, systems, businesses and people who are affected.

• Shops that catered to business employees - clothes, food, whatever - find their clientele has shrunk or vanished, so they go out of business, too, and their employees now find themselves without work.  That goes for every size of business, from department stores to restaurants to food carts on the street.  No customers = no way to stay in business.
• Cities that have built business district infrastructure to support a given population of workers now find that the number of workers has shrunk significantly, so that they no longer need all that infrastructure.  However, it can't simply be turned off.  Sewers must be cleaned;  water pipes must be repaired when they break;  electrical cables, switchboards and circuits must be maintained.  Failure to do any of that will result in cascading problems that will cost more to fix than maintaining the infrastructure.  Unfortunately, the companies in business districts, and the owners of buildings there, are no longer paying enough in municipal rates and taxes to support that cost.  What to do?
• Cities as a whole - including their schools, residential suburbs, etc. - are going to have to find enough money to support their business districts;  but to do so, they'll probably have to cut services to other areas, because they can't do everything for everybody if they no longer have the income needed to support that.  They'll hire fewer staff (and possibly lay off some that they already have), cut back on purchases of vehicles, infrastructure and equipment, defund expensive services like police and fire departments, and generally be forced to economize.  However, cities are major economic consumers.  If they cut back, they'll affect almost every major corporation in the country.

There are all sorts of considerations like that which make it difficult to foresee where the collapse in commercial real estate values may lead us.  However, we can be pretty sure it's not going to be an easy or comfortable ride.  We're already seeing sections of central business districts that are almost moribund, with most major companies having fled to more attractive (and cheaper) areas of town, leaving behind office buildings without occupants, restaurants without customers, and hotels without guests.  "Urban decay" may - probably will - become more widespread.

All of which leads me back to something I've said many times in the past, for reasons of safety and security as well as all these problems.  If you live in any of our "big blue" cities - those dominated by Democratic Party governments, focusing on ideology rather than reality, big on theory and short on pragmatism and practicality - leave them.  Now.  Go somewhere that's ruled by sanity rather than neo-Marxist theoretical claptrap.

Peter