The ongoing debate over working remotely or going into the office overlooks one major factor that could be disastrous for large cities, such as New York, Chicago and San Francisco. The commercial real estate market may be in serious trouble. According to a recent report by Morgan Stanley analysts, the commercial real estate market is expected to experience something “worse than in the Great Financial Crisis.”
Empty office space is a money pit for landlords and companies that invested millions in purchasing, leasing and retrofitting office buildings to accommodate and attract workers. Rising interest rates, oversupply and declining demand are contributing to the potential downturn. The report also notes that the impact of the pandemic on the commercial real estate market has been significant, with many businesses struggling to stay afloat and many people choosing to work from home.
If workers don’t return to the office, it could have a significant impact on businesses in big cities. According to a report from the Wall Street Journal, concerns about safety, including on public transportation, have contributed to a reluctance to go back to the office.
What Changed?
Once inflation raged and interest rates hiked higher, the economy started to retreat. The glory days of relatively free money from low borrowing rates had companies— particularly tech firms—aggressively hiring. Once the companies were faced with a bleak economic outlook, Meta, Google, Amazon, Goldman Sachs and other major firms announced significant layoffs. The power dynamics shifted from bosses catering to workers to now ordering them back into the office.
What Will Happen If People Don’t Return To The Office
According to a report from the New York Times, San Francisco’s office vacancy rate increased to a record high of 29.4% in the first quarter, around eight times the pre-pandemic level. New York has a 43% decline in leasing in the fourth quarter of 2022 compared to the same period in 2021, according to Commercial Observer.
With fewer people commuting into cities, they stand to lose their luster and reputation, as being the local epicenters of commerce, finance, media, entertainment, tourism and a vibrant social scene.
If workers continue to work remotely, it will further disrupt the ecosystem of restaurants, bars, clubs, gyms, nail salons, haircutting establishments, retail-shopping stores and an array of other businesses in urban areas. Without the steady flow of people into the city, mom-and-pop shops and an array of businesses close shop, as they don’t have enough customers to keep them afloat.
For example, New York City businesses are losing customers and revenue with people working remotely. The workers coming into Manhattan are spending $12.4 billion less per year than they were before the pandemic, according to a Bloomberg report citing data from Stanford University economist Nicholas Bloom’s WFH Research team.
Bloom’s survey analysis indicates Big Apple workers are spending nearly $5,000 less per person in the areas near their offices, ranging from grabbing breakfast, ordering lunch or taking clients to dinner and a show. This signifies the largest loss per employee of any major city in the United States.
When business is down, tax revenue also declines. As a result, the city will have to cut back on municipal services. This means less hiring and accelerated job cuts to police officers, firefighters, sanitation workers, mass transit personnel, nurses and teachers.
Last year, concerned about a downward economic spiral, New York City Mayor Eric Adams met with 100 chief executive officers, in an effort “to get their workers back into the office to stimulate the city’s economy.” Adams said, “We can’t send mixed messages,” by delaying the return to work dates. “We can’t keep kicking the can down the road.”
Adams explained his thought process. The local economy depends upon people coming into New York. “That accountant from a bank that sits in an office, it’s not only him. It feeds our financial ecosystem. He goes to the cleaners to get his suits cleaned. He goes to the restaurant. He brings in a business traveler, which is 70% of our hotel occupancy. He buys a hot dog on our streets; I hope a vegan hot dog, but he participates in the economy.”
The Challenges Confronting Commercial Real Estate
There is growing fear over the $20 trillion commercial real estate market. Higher interest rates and inflation are anathemas to commercial real estate. Remote work left many commercial buildings empty, as people worked from home. Lower building occupancy results in falling property valuations.
According to the Wall Street Journal, large commercial real estate company Brookfield Asset Management defaulted on prime building, and investment management firm PIMCO also defaulted on a mortgage.
This trend could harm the already-reeling banks. If people opt out of going to the office and stay away from inner cities, the prices of buildings will plummet. If things don’t change, the banks may take possession of the commercial buildings.
The lending to commercial real estate developers comes largely from small and regional banks—the same ones already experiencing challenges.
Fox Business reports that smaller banks hold around $2.3 trillion in commercial real estate debt, including rental-apartment mortgages. This could lead to a ripple effect on the banks, as they may struggle to recover the loans.
According to Richard Ramsden, a Goldman Sachs research economist, banks are expected to pull back on commercial real estate commitments.
Source: Forbes
