In San Francisco, a 20-story office tower that sold for $146 million a decade ago was listed in December for just $80 million.
In Chicago, a 200,000-square-foot office building in the city’s Clybourn Corridor that sold for nearly $90 million in 2004 was bought last month for $20 million, a 78 percent discount.
And in Washington, a 12-story building combining office and retail space three blocks from the White House that sold for $100 million in 2018 recently sold for just $36 million.
Such steep discounts have become the norm for office space across the United States as pandemic trends of hybrid and remote work continue, hollowing out urban centers once teeming with workers. But the losses don’t just affect commercial real estate investors. Cities are also bearing the brunt as local budgets that rely on taxes tied to valuable commercial properties now face deficits and are considering cuts as lower property value assessments lower the tax burden.
“They’re selling at massive discounts,” Aaron Peskin, president of the San Francisco Board of Supervisors, said of office buildings in his city. “If you were the people who bought at the top of the market, you’re taking a huge discount.”
Mr. Peskin said San Francisco’s $14 billion budget may face a $1 billion deficit in the next few years, due in part to lost commercial property tax revenue.
“In the short term, that means less money in municipal coffers and a less robust downtown,” he said.
Since the pandemic, cities across the country have benefited from an economic recovery and an injection of billions in federal relief money disbursed as part of the 2021 American Rescue Plan. This left municipalities so flush with cash that they gave city workers pay raises, renovated local basketball and tennis courts, and modernized sewage systems.
But now budgets are starting to tighten.
A financial report released last year by the National League of Cities found that optimism among local finance officials is beginning to fade amid concerns about weaker sales and lower property taxes that come with the expiration of federal funding.
Cuts could lead to what Arpit Gupta, a professor at New York University’s Stern School of Business, has called an “urban doom cycle” in the United States.
In a research paper updated late last year, Mr. Gupta and his colleagues estimated that the national office market lost $664.1 billion in value from 2019 to 2022. To fill budget holes created by lost tax revenue, they assumed that cities could cut services or increase other types of taxes. However, this would also have disadvantages, including encouraging businesses and residents to leave the country, which would exacerbate the problem by further eroding the tax base.
Mr. Gupta compared the dynamic to the dilemma experienced by Rust Belt cities in the 1960s and 1970s, as manufacturers shuttered and local governments struggled to balance their budgets.
“Some cities that tried to raise taxes and cut public services found that these responses accelerated the process of urban exodus,” he said. “It’s kind of gotten worse.”
The stress on the commercial real estate sector has been evident since the pandemic accelerated the remote work trend. That was complicated by high interest rates that made refinancing expensive and stress in the banking sector, which holds about $3 trillion in outstanding commercial real estate debt.
The situation is reminiscent of the turmoil the commercial real estate sector experienced during the 2008 financial crisis when credit dried up. This time, however, changes in how and where people work suggest that a deeper structural shift could be taking place in the market – at least until interest rates fall.
Glen Seidlitz, principal and founder of Washington-based commercial real estate advisory firm Six23, said many building owners and investors are trying to restructure their loans and, in some cases, are looking for new capital. However, the sector is largely in decline due to lower utilization and higher credit costs.
“It seems that lenders really recognize the fundamental problem: if interest rates remain higher, that means there will be less capital available to purchase property, and if there are fewer buyers to purchase property, prices will naturally reflect lower demand “said Mr. Seidlitz. “And as long as there is no stability, this spiral will just develop as a function of that.”
Concerns about commercial real estate increased last month when New York Community Bank disclosed unexpected losses on real estate loans tied to office and residential buildings, causing its shares to plunge. At a congressional hearing in February, Treasury Secretary Janet L. Yellen acknowledged that the sector could pose financial risks and said regulators would be watching for signs of trouble.
The risks to municipalities depend on how dependent their tax base is on revenue from commercial real estate.
A Moody’s Investors Service report last October said Atlanta and Boston’s credit ratings were most vulnerable to swings in commercial real estate prices, but upheaval in that sector would pose a threat to major cities in the next few years.
“The shift to more work outside the office, compounded by the already existing trend toward increased online shopping, has resulted in a significant portion of spending moving away from business districts,” Moody’s analysts said in the report.
Thomas Brosy, a research fellow at the Urban Institute’s Tax Policy Center, noted that falling valuations tend to be a “lagging indicator” as new leases fetch lower rents and owners appeal tax assessments when other buildings sell at low prices. He suggested that cities will have to make difficult decisions about spending cuts and tax increases within the next three years.
“It’s going to start being painful,” he said.
Large metropolises are already preparing for the worst.
San Francisco, which is experiencing a flood of appeals against commercial building tax assessments, has had to defer maintenance on city facilities to save money. Mr. Peskin, who is considering running for mayor of San Francisco, said he has pushed for policies that would encourage the conversion of vacant downtown office space into housing.
The New York City Comptroller last summer depicted a “doomsday scenario” in which the value of the city’s offices was 40 percent below its pre-pandemic peak. This would result in budget deficits of approximately $322 million in 2025 and $1.1 billion in 2027.
In Washington, where the office vacancy rate exceeded 20 percent at the end of 2023, the budget situation is also dire. Some of the capital’s best office buildings are plastered with signs advertising leases, while downtown retail spaces sit empty.
The owner of the Washington Wizards and Washington Capitals has sought to vacate the city’s Capital One Arena and move the teams to Virginia, potentially dealing another blow to a downtown already struggling with restaurant and retail closures. The business group DowntownDC Business Improvement District estimates the arena helps generate $341 million in annual spending.
The city’s chief financial officer, Glen Lee, predicted last year that Washington would face a $464 million budget deficit from 2024 to 2026, attributing much of that gap to declining commercial property tax revenue. In an update last month, Mr Lee warned that the sector’s situation was deteriorating more than previously expected and that shifts in demand for office space could have lasting consequences for Washington.
“As more people work from home, there will likely be significant changes in the county’s transportation and office real estate sectors,” Mr. Lee said in a letter to the mayor and city council leader about the capital’s finances. “With fewer commuters, there may be less demand for public transport and office space, potentially leading to a decline in property prices.”
He added: “Overall, the pandemic and the shift to remote work are expected to have far-reaching economic consequences for the district.”
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2024-03-15 15:38:51
www.nytimes.com
