Office space vacancies in US and London reach at least 20-year highs | Hacker News Reader

Office space vacancies in US and London reach at least 20-year highs

ft.com

60 pointsthm51 comments

"A falling knife has no handle"

As much as I like the idea of cheaper urban real estate, I think people are forgetting a few things:

* This could likely precipitate a huge mortgage crisis if valuations across the board get cut without some sort of soft landing

* Revenues for city governments are in the dumps already because of office vacancy. Most of this cannot be rezoned to lower cost residential without city councils admitting huge permanent revenue cuts. And there are plenty of examples of cities governments killing themselves rather than accept devaluation

* Declining city revenues also mean less budget for cities to provide services that keep themselves desirable. So you are moving more people downtown and have less money to provide them with police, busses, sewer, homelessness, etc.

* The only reason expensive urban housing is desirable is because of the presence of economic activity in town! So if you downsize the commercial zones the city will also be hurting demand for their housing stock!

So keep in mind that this is mostly a crisis for city governments. And right now they are looking at a potential death spiral situation with no clear bottom.

Put another way, cities don't really have a model for how to maintain themselves in a declining real estate market. All they see is Detroit.

This doesn't make sense to me. Land values have skyrocketed in the last two years. If prices fall, I don't know, thirty percent, what percentage of owners would be underwater? 10%? 20? That doesn't seem like any sort of feedback loop, it seems like a correction.

To put things in perspective, the 2007 economic crash was triggered by only a 6% dip in housing value! But that 6% dip was enough to snowball into a 34% crash. I don't think we are looking at nearly the same situation here, but so much of the value of real estate is tied into the future value of all neighboring real estate that it can be much more intertwined than people realize.

Like, if the city announced that it was going to have 30% less jobs in downtown SF, you would better believe that you have just not turned a commercial real estate crisis into a residential real estate crisis in SF as every home loan now takes a huge hit on it's future value.

But again, most of the crisis is on the city planning level. It's one thing for the real estate market to correct, but SF would only get to enjoy a fraction of the savings from real estate but still expect huge outlays per resident.

What are some examples of city governments killing themselves rather than accepting devaluation? Most bankruptcies of declining cities have been driven primarily by union contracts plus pension and benefits obligations to retirees. It doesn't help for politicians to accept the situation when they're locked into contracts with no room to maneuver. Then Chapter 9 bankruptcy becomes the only solution to force the workers and retirees to take a cram down while preserving essential services.

I can try to find a few examples, but there are plenty of cities who steadfastly refuse to give up concessions to businesses or open up land for development on the grounds that it is being undervalued in the market.

Even in my parent's small town there is a string of derelict businesses on the main street. But the city council has way too high expectation on what value they can get for it. So rather than rezone or redevelop the property, they have let it sit vacant for 20 years and shake their fist at the skies that no one wants to scoop it up at the "market value".

I don't understand your point. What is the zoning on those vacant properties today? What zoning change would increase their market value without seriously hurting quality of life for residents? Have any developers applied for zoning variances and been denied? Are the properties owned by the city itself, or by private entities? If the latter, eventually they will be sold at the market price and the city government will have no say in that.

I think you have it backwards. The zoning change would be to dump "expensive" commercial real estate into cheap residential or mixed. In this case they are privately owned but basically under the receivership of the city council. This is a small town in the boonies, so there isn't anybody with the time or the capital to force through zoning variances.

There being a "market price" kind of assumes that real estate is a simple commodity, but cities themselves usually excerpt some control of their own destiny. Once you move out of a desirable coastal location you generally won't take for granted the amount of effort cities take to attract jobs.

So some of it is zoning, some of it is infrastructure, and some of it is raw concessions that a city demands or gives its businesses.

Good. Now let's see when the rent - and thus valuation of real estate - starts falling; because even if this particular space can't be used for housing, it will drag down housing rent/prices as well.

Aren’t commercial real estate owners famous for not lowering prices? They don’t want to accept a lower rent amount as it lowers the valuation of their portfolio?

Yes, that's true, so the true impact of these vacancies on other aspects of society won't be visible until (and if!) they start actually lowering the rent despite having various reasons not to want that.

…or they start defaulting on loans because they don’t have the cash flow to cover payments.

It’ll typically only happen when they’re insolvent anyway, and can’t make payments.

I didn't think they could, because of the loans on the properties.

I'll have to dig up the explanation, but basically they take a loan for a $100 property, and if they dropped the rent then basically the loan becomes invalid and they have to repay 100%. So they will never lower rent, even if it's only kicking the can down the road because otherwise it's immediately an issue.

I could be wrong, so I'm going to try and find the source.

Yes this is true. The banks will insist on repayment of the difference since you're proving that the value of what you borrowed against is suddenly much lower.

That is when Bankruptcy kicks in. Many commercial properties are owned by holding companies, nearly all by some kind of liability shield.

In the US maybe but here in Europe bankruptcy is not really the "get out of jail card" as it is in the US.

In what situation would a bankruptcy of a company not limit the losses to the company? (And prevent individual bankruptcy of officers or shareholders, assuming no fraud or the like)

That’s what both companies and bankruptcy are about no?

Commercial loans are harder to get and costs/interest are much harder because of these risks. Terms are very different too.

What happens is they do a wil-e-coyote (never look down!) until/if they are forced to. Usually because of insolvency. Then the whole system collapses. The receivers/banks, if it happens, then end up lower rent or selling wholesale to the next company who rents it lower.

The sheer size of such a collapse would tend to get regulators involved though. Think what’s going on in China, etc.

Yep, but they don't ever want to admit failure so keep rents high until they are bankrupt.

Vacancies do not correlate with pricing for commercial real estate largely because of outside forces.

It’s one of the factors causing real estate illiquidity - same happens in residential.

People really don’t want to materialize losses, and will do anything they can to avoid it. It’s why property prices aren’t falling much in residential yet either, except in markets with marginal owners.

And it often works - if it’s just a temporary bump in the road, things recover and blam - they’re rich again.

If it keeps up, at least they’ll have a lot of company and they’ll be less likely to be singled out/more likely to get a bailout.

Atleast in residential rents can and do drop because a large number of rental properties are small time homeowners whose mortgages are not contingent on maintaining a high rent

It depends on the market segment. Most areas, high end/luxury type units are owned by the larger commercial investors and have the same issues. Prop mgmt companies have been doing ‘free month of rent’ type deals for a long time to avoid impacting the headline rent rates for that reason.

Commercial equivalents are usually the Class A stuff. Class B/C is often owned by individuals or small syndicates.

This is what they also call on Wall St a "margin call". Essentially, the loans are secured against the property. If the property value gets close/below the margin, the bank will liquidate the assets to secure its funding.

Not really. The vast majority of commercial real estate loans have fixed terms and are not callable.

There are also tax benefits to keeping rent high. Essentially you can write off the profit of one property with the "loss" of the other. The amount of "loss" is usually the last rent price. There are caviats of course.

I think you have a misunderstanding of income tax law. In the US at least, failure to receive rental revenue isn't considered a loss for tax purposes. The last rent price has zero relevance for income tax accounting.

Commercial property owners can generally deduct expenses like security, maintenance, utilities, etc but that's separate from rent or lack thereof.

Thanks for correction.

What if they can't find a tenant. I do not imagine all commercial property is financed with leverage. There will be properties that have paid off their debts. Loan will be recalled if they cannot find a tenant.

Outside of small properties owned by individual investors or syndicates, pretty much all commercial property is financed with leverage. Often there is a separate holding corporation established for each property. Depending on the covenants, the lender may not be able to immediately call the loan in but refinancing is going to be a problem when the term is up.

This may be a trivial question but do they continuously refinance with leverage? Let's say that the property was built 20 years ago, has been operating since then, will there be any mortgage left on it?

Yes, the usual practice is to refinance periodically. It's common for those loans to be for 10 years, but terms vary.

That's not quite right. But if rents dropped below the loan payments then the property owners really have no choice other than to go into foreclosure proceedings.

And the banks that have to undercut these loans (and maybe society in general) would really, really like to avoid having trillions of dollars of real estate come up for foreclosure again.

These real estate holders aren’t on 30 year fixed mortgages though, eventually they’ll have to roll over their debt, and they’ll be upside down and have to sell.

Once that happens they’ll have to reprice to the market.

You're right about the incentives, but in that case the property gets foreclosed and sold at a loss. So the new owners can charge a lower rent profitably.

We're already seeing Office buildings selling at 60%+ losses off peak valuation in SF, for example.

Rent in my city, Denver, will always go up. There's what I consider to be an elaborate price-inflating scheme in place to artificially increase demand and reduce supply at certain times of the year.

Move here in November, and you'll get lease options that cap the renewal date 2+ months away from it being a full year, but no year long option. Do that a few times and you'll finally get the year option available and priced to a point where you have to select it.

That puts you in the May-June range for renewal. This artificially increases demand in these months. Which is the same time at least half the city is performing a renewal, which artificially reduces supply, as nobody will give up their place until they find a new one. So there's overlap in apartment availability.

There's a huge push to keep you in this cycle. If you decide NOT to renew your lease and go month to month, the rent jumps 35%/month. If you leave your lease partway through, some leases expect you to pay that 135% rate for the full remainder of the lease term if someone doesn't take the apartment. If someone DOES take the apartment, you have to pay 135% minus whatever they lease it for. The building could lease it for a buck and you'd still be on the hook until the lease is out.

The reason it's a price-inflating scheme is that the same formula is run by all 5-6 major rental companies which run the majority of apartment buildings in the city. It should be easy to identify collusion by the similar business practices (proof of communication is not required), but there's no will and the city doesn't investigate.

So, they expand beyond price fixing to other mechanisms. Like a 7 year rental history record that all the buildings pay into and take the word of so that their rental discrimination has block-power. It's not just eviction discrimination anymore. There's an unregulated credit bureau which builds the authority that building management have over their renters. Refuse to pay a charge, for whatever reason, and you're blocked from decent housing anywhere this rental history service is used.

This will prevent you from finding an apartment elsewhere due to rental history discrimination. You could end up in one of those places pretending to be a hotel but which functionally is just exploitative housing for poor people with bad rental history. They pay an inflated rate (2x a typical rental) for a much worse room that has no eviction protection. For people with low income this means a longer time paying back rental debt, or potential homelessness.

Corporate exploitation of rental markets is one of the roots of the homeless crisis. But it's also a driver of home value increases. So we never hear about them when politicians are hand-wringing and talking about solutions while they shift around the growing tent cities.

Good, Now turn those empty offices into housing

And re-open the local shops, instead of having every one close in on the concrete hell.

That would actually require demolishing them and building residential buildings from scratch. Most office spaces are not designed to be inhabitable 24/7, they would suck as apartments.

And yet it happens https://www.bbc.co.uk/news/uk-england-essex-47720887

Wish granted. They'll be turned into luxury apartments worth $1M a piece, bought by foreign investors, and vacant 364 days a year.

There’s easy solutions to that if it ever becomes a problem (the easiest is a vacancy tax) but it’s not currently a problem in the US as can be seen from the fact that places which have built more housing in the past decade or so have much lower rents than similar places that haven’t built as much housing.

Arguably it is already a problem. NYC's "Billionaire's Row" is crammed full of apartments built for the sole purpose of investment and remain vacant. Imagine how many homes for "regular" people (yes, it's Manhattan, they'll still be expensive) could have been built there if there wasn't a financial incentive to bury money like this.

These skyscrapers buy "air rights" from neighbours to build high which takes away even more homes.

London has areas with the same problem.

https://www.youtube.com/watch?v=Wehsz38P74g

This is kind of a whataboutist point.

Places like NYC and London fit a kind of niche where there is a market for this sort of opulence/money-laundering. But if you, like, sit on a bunch of commercial real estate in Des Moines Iowa, turning it around into a $50 million apartment for the Saudis is not a real possibility.

NYC's primary problem is having the worst housing production rates of any major US city (aside from a handful that are economically struggling and have low production from outright lack of demand), and the downstate/LI suburbs being exceptionally bad as well.

The rest is basically irrelevant. Every one of those few "billionaire" buildings could be 1-bedroom market rate units at 100% occupancy instead and it wouldn't do anything significant for the overall problem.

For one example of how broken NYC policies are: 60% of residential lots aren't zoned for anything over 2 stories. The city needs to have much of it moderately upzoned to get decent (and decently distributed) housing development, not to somehow start building affordable skyscrapers in Midtown.

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There's a fantastic non-partisan report here that lays out the scale of the failure and various ways to improve the issue very clearly: https://cbcny.org/research/strategies-boost-housing-producti...

If you want to just skim, the various charts show it clearly enough without actually reading every paragraph.

Vacancy tax seems like an easy solution until you start thinking about implementation. How do you expect to enforce it?

Make the penalties very harsh, and allow whistleblowers to collect a percentage of the fines.

NYC just charging not insanely low property tax, especially on these billionaire condos would be a good start.

Odd, considering london tech workers have largely been ordered back to offices so some can feel less lonely. Perhaps non tech workers have it better? Which wouldnt surprise me considering tech work in the uk is treated like construction work according to pay.

I wouldn’t say it’s that bad. More like mid level accounting or experienced fork lift operator.

I predict vacancies office rent will end of startup led open floor plans. Return of private rooms in offices. Prediction 5-10 years from now. Reason zero interest rates inflated real estate value which made office space more expensive. Now that there is vacancies office rent will plummet. Cheap office cheap rooms enables private rooms for developers.

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