Another big potential threat to the U.S. economy may lurk in corporate skyscrapers in the country’s downtown districts.
With many people still working from home, companies are cutting back on so much office space that it threatens to put even more strain on the US economy.
The unraveling of the office sector spells trouble not only for banks, which owe about $1.2 trillion in unpaid office loans, but also for countless small businesses that depend on white-collar clients, as well as cities that benefit from property taxes tied to buildings office.
This is a worrying development in the commercial real estate industry at a time when the US economy is already showing signs of stress and perhaps even recession.
Here are some ways empty offices in America could hurt the economy even more:
Owner default and foreclosure
Almost 20% of office space they are currently empty throughout the United States. That’s a milestone that exceeds the vacancy rate during the 2008 global financial crisis, and is worse off in places like San Francisco and downtown Los Angeles, where more than a quarter of offices are vacant.
According to analysts, if companies continue to abandon lease agreements and the demand for office space remains weak, office owners will not be able to collect the rents needed to keep up with the repayment of commercial loans.
Many of these loans are due next year, and building owners will have to refinance their debts at a time when low occupancy has reduced the value of buildings and interest rates have skyrocketed.
This means that many owners may soon be charged much higher payments.
Analysts say it could end badly.
“I’d say the number one implication would be insolvencies and foreclosures,” says Kenneth Rosen, president of real estate research firm Rosen Consulting Group.
Banks will feel the pain too
The increased number of insolvencies and foreclosures would likely send shockwaves throughout the US banking system.
Most of the $1.2 trillion in office space debt is owed to smaller regional banks already in turmoil with depositors fleeing to larger banks.
Three smaller banks have collapsed in the last two months. This problem continued to spread as PacWest Bancorp’s stock hit last week.
If office owners are unable to repay their loans and eventually hand over the keys, banks will have to find new buyers, a difficult task when interest rates are high, credit is shrinking and concerns about the economy are growing.
All of this has been caught attention of decision makers.
IN report published on Monday last week, the Federal Reserve said it had increased and expanded its control over commercial real estate lending and the banks that frequently grant them.
Precipitation can turn city centers upside down
The surge in vacancies is already turning the inner city center ecosystems upside down.
Dry cleaners, shoe laundries, restaurants and convenience stores that have long depended on heavy foot traffic five days a week are struggling to survive.
“I currently have maybe four or five customers a day,” says James Wallace Sears, owner of a shoe repair shop in downtown Los Angeles, adding that his monthly sales are down 85% compared to the COVID-19 pandemic. “I’m here starting over to see if it still works, but I don’t know.
For public transport systems, fewer commuters and the end of pandemic aid are contributing to budget deficits and predicted huge shortages.
And for local governments, high vacancy will mean a decrease in property tax revenues, which will burn a hole in the city’s finances.
The owners are desperately looking for solutions
The commercial real estate market has several good options.
Some landlords are looking for ways to convert their office buildings into apartments, which would help alleviate housing shortages, but not all buildings can be smoothly converted without major upgrades and costly remodeling, and that’s a major undertaking given tighter lending conditions and higher financing costs.
Brokerage firms and owners are doing everything in their power to attract new tenants to their high-end buildings.
Cushman & Wakefield offers helicopter tours of its new downtown Los Angeles offices on the very expensive premise that high-end spaces with trendy restaurants, luxury fitness centers, on-site childcare and spacious workspaces are enough to lure businesses and employees back.
So far, the demand for these high-end spaces seems promising, but engaging in them in times of great economic uncertainty is a risky gamble that analysts say will not be enough to save the entire office sector.
The more sure-fire solution is one that many employees are unwilling to consider: ending remote work and aggressively returning to the office full.
Also, cities and businesses that once thrived on knowledge workers can fail—or even fail—without them.