Office Landlord Defaults Are Escalating as Lenders Brace for More Distress
wsj.com
wsj.com
Markets as optimization tools only work if people are made to suffer their losses when they occur; bailouts subvert the process and pervert the outcomes.
Where demand falls: decommission or repurpose the schools.
They probably would need to expand, though.
Except in my town, as is fairly common, an incremental student costs more than the contribution from local property taxes and the state. So the fairly rural town of about 7,000 generally resists any plans that would markedly increase the number of students in the town.
So presumably adding more students and families is what makes it affordable. Why does that stop? What's the inflexion point?
It's not that a few students more or less is an issue but if there were a big new development with a lot of families with school-age children that would likely be a problem for the town.
It turns out zoning is not just an arbitrary categorization, but also a guidance for public works. This is a tough trap, because it's hard to convince a local gov to put up much more capacity than required for office use when an office building goes in (that would be a waste of taxpayer funds).
(I've tried to do this, even put up capital and hired an architect, but it hit this wall.)
Also newer cities in the US tend to not be denser. Because of zoning.
I've read that converting actual office buildings is tricky and often not worth it outside of all but the most expensive housing markets, but that's different from liberalizing the zoning regime.
One reservation I have is what zoning we get rid of and where. Many cities such as Columbus where I live have fantastic, medium-density neighborhoods that we really shouldn't touch. On the other hand the downtown area is full of surface parking lots that are not only empty most of the time in the evenings but post-COVID empty most of the time all of the time. Something I'd advocate for in a 1-2 punch would be to remove parking minimums city-wide but also to remove zoning restrictions in the downtown core first to create density there where we lack it before we try and remove it in our neighborhoods that we know are good and appropriately dense to start with.
Most of the density/zoning problems as they relate to neighborhoods exist in the suburbs, not cities.
You're right about the office renovation though too. That's an issue. Thankfully those buildings are owned by someone who, frankly, has to spend the money to do something useful with them. We should make/let them solve their own problem there because whatever they solve for will be good for downtown cores.
Unfortunately zoning is going to become a political nightmare. Already state governments in locations such as Ohio where I live are now working to block cities from slowing down traffic or providing alternate means of transportation options instead of the car-only (the government says you aren't allowed to do anything but drive a car) infrastructure we pay for now.
We just did that here in Bend, Oregon as part of a statewide push to have more climate friendly cities. It's a great, easy, very incrementalist and market-based reform that everyone should do.
In large commercial buildings, too much of the floor space is too far from a window. This is why dead malls are so useless.
The buildings are usually often old and cheaply constructed and would probably largely need to be gutted which is probably not worth it.
But even if you contemplate just building from scratch, if a mall is dead it's probably because it's located somewhere there isn't a ton of demand. That's certainly the case with the one near me.
It could still house some residential use, albeit very few large units. Wouldn't probably be profitable.
What's the alternative? Teardown and rebuild?
However, that aside, I don't think the GP is suggesting rezoning office towers in a downtown core such that they get torn down and replaced with equally-dense condo towers. I think the much more common use-case that everyone wants to see, is taking the land on which sits e.g. an abandoned mall, or a disused business park, or something else that's not already surrounded by hard-to-work-around density; rezoning that land to mixed-use commercial+residential; and then selling the land to a property developer (who then incurs the costs of infrastructure building) to blow it away and replace it with a "village" of midrises + shopping laid out for walkability.
Or, alternately, we can approach things from the other angle: upzone light SFH-only residential, into mixed-use medium-density residential + commercial. I.e. tell property developers that they're free to buy up stretches of homes and plop down 5+1 apartment buildings with shops on the ground floor; and also allow anyone living in a home in the area to run a corner store, bistro, dance studio, hair salon, or other (non-industrial) businesses they like out of their house, with no need to apply for a zoning permit.
In short: why try to cram more people into downtown, when you can instead spread out the benefits of living downtown?
This strikes me as the low hanging fruit when it comes to making cities more walkable.
Are you sure this is true? Water distribution is usually constrained to minimums required for the fire suppression loads and duration. Typically, as far as I know the NFPA 1 standard is based on the construction type based on materials and design defined IBC chapter 6, and square footage, not on use or occupancy classifications.
Now the BUILDING plumbing would be a different story entirely. That would change dramatically from offices to commercial/residential uses.
But, you said city infrastructure, so I'm curious what wall you ran into exactly?
On the other hand it might necessitate upgrades if all R1 units are converted to R3, but then you have three times more taxpayers per mile to pay for that infrastructure.
Good book for the curious: https://islandpress.org/books/arbitrary-lines
So instead of specifically limiting heavy truck access on a given street, it tries to limit the type of buildings.
Much of zoning could be fixed by directly aiming at the problems instead of just saying "only single family homes are permitted here".
That's one of many reasons that a lot of the better reforms we're seeing are at the state level, where it's easier to do the right thing and where politicians are less beholden to a few local loudmouths.
Economic segregation is really a different issue, and it is not something you are going to fix with legislation. The people with money will always be able to live someplace acceptable to them. A government can force most entities to be non-racist through various laws and actions. But you really cannot force someone to live next to an area they do not desire.
You could get rid of that zoning that enables wealthy people to say 'no' to other types of housing. Sure, they can always buy up a big lot somewhere far away - fine, whatever. But where cities are growing, that kind of discrimination embedded in the local zoning code is not ok.
And you can legislate it away - Oregon was the first state to do so with HB2001, which re-legalizes up to 4-plexes in all our cities. In any neighborhood. A 4-plex in a posh neighborhood is still not going to be cheap, but it allows more integration than if it weren't legal to build at all.
This is different than thinking there is going to be a large number of upper income single family housing units that would find living next to a Section 8 kind of development desirable.
I know people who grew up in "affordable housing", and put in significant effort to get away from that kind of neighborhood, and would not want to live near one.
This is a real challenge, and it can't be legislated away, the fix (IMO) is far deeper than zoning changes.
How do you square that with the fact that racial minorities are significantly poorer on average?
> it involves excluding a person based on something out of their control
Are you implying that people choose to be poor?
Most people don't want homelessness, "gangs"/crime , and rundown houses and other unsightly signs (perceived or real) of the economic lower-class in their neighborhood, a smaller subset don't want their children to socialize with the lower-class children, and a smaller subset truly want a private enclave of elitism.
To be frank, there is a benefit to live near lower-income people: its easier to find service workers for your local cafe/restaurant/etc. The affordability problem facing many cities is that there are too few service workers because not enough people can afford to go to the city and work (because commuting from affordable areas isn't worth it). A city with a varied population can support more local businesses, and can have a more varied local economy, and can even be more resilient - eg. if there is a big storm, but the town has no plumbers, electricians, etc, you may need to pay more to "import" that workers from doing jobs in their own town (which also likely has residents in need of work). If you are a millionaire, you can pay to import service work, but most middle-class people can't.
As in, keeping industry apart from other uses is a good thing the current zoning system does. But we should loosen restrictions elsewhere: offices, housing, commercial, and light industrial should be mixed more, which is forbidden under current laws.
I tend to agree. I live in a city where the downtown dies after 6pm, and it's a real shame knowing what it could be.
That really varies quite a lot. My town has a lot of mixed use zones. But a few towns over, they only have the usual variations of residential, employment, commercial, along with a few niche zones (university, open space, county government, etc).
In most of the developed world stuff like this often ends up the east side of town, because in the northern hemisphere prevailing winds usually come from the west. Poor people often end up on the east side of towns for the same reason.
Which is why you know they're gonna do it. Can't let market forces get in the way of a good "campaign contribution", right ? :/
With the unfortunate side-effects of fewer vehicles, lower emissions, better traffic for those who do have to travel, and more economic efficiencies.
This is such an important aspect of optimization that is often forgotten. Small crashes have to happen and as much pain as they cause, they are nothing compared to what will get heaved if they turn systemic. They have an important function of keeping the players honest and up to date about their risk models. In a world where nobody is allowed to fail, risk taking will balloon monotonically until the entire system fails. This is basically axiomatic.
Real estate investments are again seen as a risk free asset class, where the only way is up. You know things are bad when we have landlords clutching their pearls about having a negative year of returns. This is nuts. The pain is important. It reminds everyone about the left tails and that they should de-lever carefully now, before things get amplified into a systemic crash where controlled de-levering becomes impossible.
The CMBS crash is very likely to be systemic.
Corporations already exist to shield their owners from consequences of their decisions.
And really that last sentence is the problem.
Even if the companies fail it lands on the stockholders, who often had no idea what was going on, a good chunk of them having bought the company through 401(k) funds. The executives go on to other businesses and there's no real consequences for the humans that actually made the decision.
We need to really end the fiction that its the legal entity of corporations that make decisions and should be punished. In reality its the humans behind the curtains doing the deciding, that curtain needs to get stripped away if there is to be real consequences.
The Lucky supermarket is becoming a Whole Foods. The Orchard Supply Hardware was a Goodwill for a while, and now it's going to be a Costco. The Rite Aid became a dim sum palace. A Chinese restaurant became a Sprouts grocery store.
None of them became homes. Why not? I can only guess, not being in that business.
Though obviously a stand-alone grocery store or such would be easier to knock down and replace with residential, vs. a (say) 5+ story office.
(And the article clearly focuses on much taller office towers.)
In high cost areas, most of the cost comes from land acquisition, permitting, and various impact fees or mandates (like requirements for BMR units). The construction cost is a relatively small fraction. Might as well demolish the existing structure and rebuild from scratch.
Moral Hazard
Here is a relevant stat: 150 million Americans own some type of investment in REIT’s. Even if you don’t believe the number, I betting that the order of magnitude is correct.
https://www.reit.com/data-research/research/nareit-research/...
Their losses become our losses when the failures create systemic risk of a banking and financial collapse.
A total lockup of the US financial system would mean that companies with a yearly business cycle wouldn't be able to make monthly payroll and ATMs would stop working.
You can't isolate the pain down only to the bad actors, everyone suffers.
If wall street builds a shitty nuclear reactor and it melts down in the middle of Manhattan, there really is no option for "well just let it fail" because the fallout will cover the area. It works the same way with finance. Once the whole system is at risk then the government has to act in order to save it.
What needs to happen is regulation up front. Once the financial system is melting down then the system has to be rescued.
What we could alternatively do is at least jail the executives and remove the liability protections of working from within a corporate structure. But the idea to just let everything fail is how you destroy the US financial system.
And we actually tried that back in 2008 when the Bush Administration let Lehman fail. That was bad enough that it would up with Paulson down on one knee begging Nancy Pelosi to not play politics and to rescue the financial system.
My last job had a terrible office, $30k a month in rent. The building required we use all their contractors and designers for everything, no surprise it was the brother and sister of the building owner. Any change in layout had to be run past an approval process that was slow. Even the services were overall disgusting, damaged ceiling tiles, AC didn't operate properly (e.g. rooms that only had intakes thus you couldn't close the door without hurting airflow).
Landlords have been a menace for most businesses over the last 30 years as the expectation has become 'easy money'. Gordon Ramsey highlighted it best, the busier your restaurant gets the higher the rent keeps going. They scout your business and charge you just enough for you not to move...
This does exclude the expense of expanding / renovating the office, which you typically do every 5-10 years, and costs more because you have to go with their contractors. However the delta is hard to calculate on this specific item.
The land speculation, education, healthcare trifecta cost spiral in the US has to be like half of peoples' wages.
There's a reason it's called "rent seeking".
Because it's convenient terminology, not because it's exactly on point. When a company (or individual) leases/rents, they are definitely getting some value in return. Owning has both upsides and downsides.
The simplistic "all landlords are of the devil and must burn" is about as useful as "nobody should own property" - perhaps a nice dream but they don't really help advance the discussion or solve the very real problems that exist.
Silicon Valley’s office vacancy rate increased again in Q4 2022 to 19.0%, up from 18.6% in Q3. The end of 2022 marks the 12th consecutive
quarter where the overall vacancy rate has risen. Campbell’s vacancy rate for in Q4 was 30.0% with negative 278,167 of overall absorption.
Silicon Valley’s average asking rent increased slightly in Q4 2022, rising to $5.36 psf on a monthly full-service basis, a $0.02 increase
from the previous quarter and a $0.04 increase year-over-year. Campbell’s average asking rent was $4.18. Given the current lack of demand
for office space as well as upcoming economic uncertainty, there is little expectation that significant rent increases would occur in the
near term. Transaction volume fell sharply in Q4 2022, posting just 778,712 sf of gross absorption, a 76% decrease compared to the previous
quarter. Demand for new office space fell on the news of large-scale tech-sector layoffs this quarter that will likely persist through 2023.
The Valley measured 2.6 msf of net occupancy losses in 2022, the largest amount since 2001 and marks the third year of negative net
absorptionBanker 2: Well, let's not get ahead of ourselves. Home mortgages, yes, but a business would never default on their real estate, where would people work from?
Banker 1: That's genius, here's 100 billion dollars, go buy some swaps.
Bankers 1 and 2: pikachu face
Scene closes, title opens, "The Bigger Short"
If a developer goes under you don’t have the same systemic risk of deposits/ consumers losing their shirts as you do when a bank goes under.
Some commercial loans are considered qualifying, and don't have retention requirements.
The skin in the game requirement, notably, only acts as an incentive for issuers to write good loans. If they think the loans are good, but it turns out they weren't, I believe we're in the same situation. Especially with how money was essentially free, it seems like it would have been quite easy for issues to cover their retention requirements and still cover lots of real estate.
The impact on banks if the loans go bad should be the same though, I believe.
the conglomerate landlord has doubled down on some sort of bizarre Potemkin village strategy to ensure investors dont pull out. muzak in the courtyard is turned up to blaring at all hours of the day, a cleaning staff roams around a few times a week as well but with no trash, they just sit at the tables and check their phones for a few hours. Security guards are staffing the buildings but the doors are always locked. The office for the parking garage is completely empty, no chairs at the desks or anything.
Businesses and restaurants keep closing because corporate landlords keep raising rent by huge amounts. In this climate they keep raising rent. It’s absurd and a lot of the corporations have zero community ties to the area other than collecting rent from afar.
I know it eventually happens, but it seems like a lot of commercial landlords would rather have excessive vacancies than lower the rent to attract new tenants or keep existing tenants. Is there some kind of tax reason for it?
Going to be interesting to see what happens when that debt rolls off and needs to be refinanced.
- Compared to 2019, the average New York office worker is spending $4,661 less on meals, shopping and entertainment near their workplace, the researchers found. That dropoff is the highest of any city included in the study, outpacing Los Angeles ($4,200), Washington, D.C. ($4,051), and Atlanta ($3,938), among others.
- New York workers are spending about 33% fewer days in the office now than in 2019, according to the study. That ranks fifth among the studied cities, with Washington seeing the highest in-office decline, at 37%.
- ....Only 9% of employees in their offices five days a week—unchanged from September 2022.
- That amounts to at least $12.4 billion a year in losses for the city
- estimated 2.7 million people who worked in Manhattan in 2019.
So the trend over time will be that folks left in NYC are increasingly poor with no other options, completely eroding the tax base and sending the city into a spiral. I didn't live here in the 70s but I expected something similar.
In the early 2000s-2010s there was an interesting trend of adults moving to the city and raising kids there vs the burbs. I think that's over and done with, everyone with money and energy seems to be moving to the burbs if not to Florida.
Where do they make that up from, income tax? Sales tax?
At what point do high wage earners decide enough is enough and move to Florida or Texas?
Scary possibility for a tax funding death spiral here.
Middle class people probably get a better deal moving to Florida/Texas. High Net Worth Individuals are too rich for it to matter.
But regular old high income people (LOL) are unlikely to save any money moving to Florida/Texas if they are looking to maintain the same lifestyle.
Nice places in those states have become really expensive, and there are all sorts of other costs that people don’t always look at (like insurance, for example). In Florida, especially, you won’t know what your property taxes are until after you buy the house - except that you know that they’ll be much higher than the current taxes.
just a anecdote but my LinkedIn Jobs feed for sysadmins went from 80-90% full remote, to 80-90% hybrid, and now it is about 50-60% in office only, less than 5% full remote, and the rest hybrid for open positions, that is a national feed I have
I don't think the race back to "normality" is going to be won before the downturn starts.
I mean, if your LinkedIn feed of sysadmin jobs indicates that, who am I to argue.
Note that commercial rents at something like 10x the cost of residential per square foot, so this represents a huge loss for developers, and therefore there is a big incentive to hold on and bet that the market will pick up again.
Certainly not for the traditional concept of residential, but there are a lot of ways to reimagine residential that could be compatible (all electric, shared bathrooms, etc.)
Like if you take a 1-2k sqft pie slice of the center-to-window of a floorplate it ends up being extremely awkward to lay out a desirable apartment on that.
I'm here for the general idea of rethinking residential though; personally I think we do more harm than good by requiring all bedrooms to have windows. Cheap pod apartments could be strongly preferable for many working-class folks that presently commute 1.5+ hours into metropolitan areas. But making that work would require a deep rethinking of permitting and zoning.
And windows.
Sure there are ways to "reimagine" residential to accommodate office floorplans, but I feel that for the most part those "reimagings" would be at best depressing and probably worse. "Windowless SRO room" is not an acceptable living situation for most, and you could probably do much better with a different building on the same land.