Wednesday, January 24, 2024

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


24 comments:

  1. Given the ever increasing f the ability for large segments to work from home, coupled with the ability to order almost anything online without shopping mortar and brick, I think in another 50 years, long after I'm gone, the centers of large cities will be ghost towns.

    The tall business buildings will be dangerously decayed due to non-use and therefore non-maintenance. Nobody will want to spend the money for demolition, so they will just continue to decay.

    Possibly demolition in order to put housing in place might be an alternative.

    Turning office spaces into housing might be an answer, but that would take a coordinated effort to ensure support such as groceries, doctors, schools, etc. would be available.

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    1. It will take lots of money to retrofit the plumbing to convert an office building to be an apartment building.

      Delete
  2. Before I went Galt last year I worked in industrial mechanical contracting. Many of my clients were the major property management companies in the PNW. Work In the downtown core.

    Most of those fancy highrise buildings have been more or less empty for coming on 4 years now. Do you know what rent is in a class A office building ? Do you have any idea what it costs to keep the lights on and the water flowing in a 54 story building? Like the article said, you can't just "shut them off". How much longer can those companies keep doing that?

    Most of the competent building engineers joined me in Galts Gulch over the past few years leaving behind young inexperienced crew and DIE hires. Yes, they actually did. Yeah, the standard dropped.

    I wonder what it will be like to be in a downtown full of abandoned high rise buildings. Like grand canyon, only with more crackheads?

    Hang on kids .....it's gonna be a heck of a ride!

    ReplyDelete
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    1. You should read about the Holiday Inn in Beirut. Some peoyssy it's been fought over more than any other place on earth.
      It's on a height that makes it great for sniping and calling artillery, and it's heavily built of concrete so it works as a bunker and safe place. The interior is trashed but the walls are (mostly) solid.
      Jonathan

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    2. I spent a winter down the street from Holiday inn Sarajevo. Does that count?

      No, but seriously....I did. SFOR

      The difference between Beruit and the PNW is the moisture and the occasional freezing temps.

      Warm and mostly dry will hold up a whole lot better than cold and wet.

      Delete
  3. Interesting that the only entity that seems unconcerned with the interest rate negative arbitrage heading our way is the federal government. The collapse is coming, gradually then suddenly as the saying goes.

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  4. Big operations have been moving out of the cities for years; this is accelerating that move. It's hitting all cities, but the big coastal cities are far harder hit.
    For example, I've seen claims that San Francisco is at 40% vacancy and climbing while Houston is moaning about 23%.
    Jonathan

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  5. De-urbanization will, eventually, remove the drivers for the Drug/Mental Health epidemics as well (atomization of the individuals from tribes).

    Cities are ultimately altars for greed, sloth, vanity, and gluttony. That is their raison d'etre.

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  6. They were discussing this on the radio the other day, the guest they had in said only certain office buildings can be converted into Residential and it's a big deal to Wall Street and people are definitely reacting to this whole situation. I don't know what the solution will be. My Grandparents were small business owners who part-owned the small office building their company was in and luckily sold out to the other partner pre-covid. But how many other building owners are small/medium business people, not a huge corporation, that suddenly had the bottom drop out of their nest egg?

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  7. CRE is financed on a 10 or 15 year amortization that is refinanced every 5 years. Rates are usually prime + 1-3%. $700B might be the tip of the iceberg on defaults..

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  8. "I wonder what it will be like to be in a downtown full of abandoned high rise buildings."

    Bad. Squatters camping in them, fires. Eventually one will collapse, not neatly, and 'there goes the neighborhood'. Clearing the streets will cost too much. Later rinse repeat.

    Possibly, before that starts happening, there will be a resettlement - cities are where they are for reasons - and the old structures will be minded for resources.

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  9. Actually at least in my area there are not enough rentals. If they actually remodel into apartments(especially with high speed internet for those working from home), the new renters would help to support the downtown businesses. Yep it would be an upfront cost, but better than letting them continue to decay.

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  10. Cities may find they have some white elephants when large building owners decided to default on taxes. I doubt the owners will want to wait on an economic shift, and the defaults will be preceded by turning off the utilities with the beginning of decay.

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  11. I work for a relatively small company -- about 150 regular folks, and about 70 contractors makes it about 220-230 overall headcount.

    All the contractors are in Colombia and Vietnam. And of the "regulars" only about 80 or so are "local." Of those, only 1 regularly goes in ot the office, and even he only does it becuz our work internet is so much better than his home internet is, plus he lives less than 5 minutes from the office.

    As a result, when the lease expired this last year, our execs and board took a long hard look at no longer maintaining an office at all. They decided to keep an office after all, but downsized to a space that's only 1/3 the size of the previous office. Our annual rent will be reduced from about $750K to about $250K as a result. Thing is.... even with that, it's still largely wasted space. 1 regular attendee, and then we might get 30 or so folks in for a monthly "all hands" meeting, and... yeah, that's it.

    i was talking to one of our executive VP's last week and he told me that on a recent trip he took through Europe to visit some of our clients there that 90% of the meetings he had with them were in temporary office spaces, rented just for that meeting, and that most of the companies no longer actually had an office space at all anymore.

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  12. In my town there is a high rise (actually the tallest building in town) that was condemned all except the first floor back in the 80's due to asbestos. The owners were out of state and just abandoned it. It wasn't until last year that the mayor somehow managed to get funding from the EPA to pay to demo it (hasn't happened yet). For small towns / cities the cost to demo high rises is just not doable and even large cities will have more needed then they can afford, especially with their tax base leaving for smaller towns and cities. Something like a strip mall or shopping center is easy as they generally have lots of space around them but high rises generally don't have room around them to fall down on.

    Only slightly related but in my area the minimum wage is $11.73. No one pays that. McDonalds is starting out at $15, Lowes and Home Depot are both starting at $20. Every business is hiring. There just isn't people to do the work. I just found out the local Subway got work visas and brought in 15 gals from Indonesia to staff their shops. Not sure what they are paying them on top of housing.

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  13. |Upcoming green rules in NYC will mean the cost of converting offices to apartments will be prohibitive. There's no way out in that direction and no need for the folks to live in the city center anyway (and be one of few paying local taxes).

    Which brings me to the question, what do we need the inner cities for?

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  14. Good stuff and so true. Except, I am a refugee fro the Peoples Republic of Portland, I guarantee the libs will transition all the way to 100% property tax and beyond rather than lay off a single useless bureaucrat.
    They will fire or lay off the useful ones like police, fire, road maintenance, housing code compliance.

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  15. Well, looking here in WF, the downtown area is pretty sparsely populated with businesses... Sad seeing businesses close and seeing so many vacant buildings, but the cost to renovate them is high and who wants to be the one holding the useless collateral at the end if it does not ever turn around? Working for the University, I DO hope that the new "luxury student" housing takes off and that businesses thrive and new ones come in to fill it up, but we've not seen that yet...

    And this is a friendly area. The bigger cities? Already ghost towns, going to get far worse as this accelerates I suspect.

    ReplyDelete
    Replies
    1. Many of those old buildings don't meet current code, ADA requirements, etc, and the cost to retrofit is more than the building is worth.
      It's cheaper to do an owned new build in the suburbs, or in the case of towns, just outside of city limits.
      I have seen several places where both Walmart and Dollar General have built feet beyond the city limits sign - fewer taxes and regulations.
      Jonathan

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  16. The cities will fill with buidlings turned into more Ponte City Towers like in Joburg after the d. Oops, I mean the decolonization.

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  17. As the owner of a 5,300 ft2 office building and a 3,750 ft2 office warehouse on 9 acres in a remote area of Fort Bend County, Texas, I am little concerned but not much. I only have $140K left on my commercial mortgage. My big concern is that all three tenants are small and in financial difficulty due to remaining problems from the covidacy shutdowns. One of the tenants is my engineering software business.

    I have no idea what is coming in the future but I doubt it is good. My son says that we will call it "The Greater Depression". I've never seen the various governments this hostile to small businesses.

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  18. Well gee, there's at least 6 million illegals that the regime imported to the country. We could put them all in the empty office buildings. No need for renovations, as communal bathrooms and very few appliances are still better than what they supposedly left. Just here for a "better life", right?

    With the added bonus that we'd know where a lot of them are if there's any "trouble".

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  19. For the ordinary folk who may still live in the big cities, remember what the cimmenters above have noted, that city infrastructure is both a fixed and variable cost.
    There are expenses that must be paid regardless of how many people work of live there. Taxes will go up, crime will go up, available services and supplies will go down, residential rents will go up, and residential property values will go down.
    As these things happen, those who can will move out, or stop spending money in preparation for getting out. Thic will further damage businesses in the city, speeding the Detroiting of most American cities.
    If you can get out, do it.
    If you can buy in a self-sufficient smaller town, and support yourself there, either buy for cash, or with the largest mortgage to price you can get.
    Don't sink your money in a property and hold a small mortgage. If you lose income, you could lose both your equity and your home. With a large mortgage and fixed payments, in an inflation, you repay with inflated dollars. In a deflation, you will have to walk away, but you should still be able to keep the wealth you didn't put into the house.
    John in Indy

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  20. Millions of people coming over the boarder & they will all need a place to stay... all those empty buildings...

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