In San Francisco, a 20-story office tower 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 Claiborne Corridor that sold for nearly $90 million in 2004 was purchased last month for $20 million, a 78% discount.
And in Washington, a 12-story building with a mix of office and retail space three blocks from the White House sold for $100 million in 2018, but recently sold for just $36 million.
Such deep discounts are becoming the norm for office space across the country as the pandemic trend of hybrid and remote work continues, hollowing out city centers once bustling with workers. But losses aren't just hitting commercial real estate investors. Cities will also bear the brunt, as municipal budgets that rely on taxes associated with valuable commercial real estate are currently facing shortfalls and are considering cuts to reduce their tax burden due to falling property valuations. It is designed to stand.
San Francisco office buildings are “sold at deep discounts,” San Francisco Board of Supervisors Chairman Aaron Peskin said. “If you were the person who bought at the top of the market, you would be taking a significant cut.”
Peskin said San Francisco's $14 billion budget faces a projected $1 billion shortfall over the next few years, due in part to lost commercial real estate tax revenue.
“In the short term, that means less money in municipal coffers and less robust downtowns,” he says.
Since the pandemic, cities across the country have benefited from an economic recovery and an infusion of billions of dollars in federal relief money disbursed through the 2021 American Rescue Plan. As a result, local governments are flush with cash and are giving raises to city workers. , renovate local basketball and tennis courts and upgrade the sewer system.
But now budgets are starting to tighten.
A fiscal report released last year by the National League of Cities showed that optimism among municipal finance officials is beginning to wane amid weak sales and concerns about lower property taxes as federal funding expires. It has been found.
The cuts could create what Arpit Gupta, a professor at New York University's Stern School of Business, calls an “urban doom loop” across the country.
In a research paper updated late last year, Mr. Gupta and his colleagues estimated that the country's office market lost $664.1 billion in value from 2019 to 2022. We hypothesized that to fill the budget hole created by lost tax revenue, cities could: Cut services or raise other types of taxes. However, it also has the downside of encouraging businesses and residents to leave, further eroding the tax base and exacerbating the problem.
Mr. Gupta likened this dynamic to the challenges experienced by rusty industrial cities in the 1960s and '70s, when manufacturers closed and local governments struggled to balance their budgets. Ta.
“In some cities that have attempted to raise taxes or cut public services, we have found that these responses accelerate the process of urban flight,” he said. “It was kind of complicated.”
It's clear that the commercial real estate sector has been under stress since the pandemic accelerated remote work trends. The situation is further complicated by high interest rates that make refinancing expensive and stress in the banking sector, which has about $3 trillion in outstanding commercial real estate debt.
The situation is reminiscent of the turmoil experienced by the commercial real estate sector when credit dried up during the 2008 financial crisis. But this time, changes in how and where people work suggest that deeper structural changes in the market may be beginning, at least until interest rates fall.
Glenn Seidlitz, president and founder of Six23, a Washington-based commercial real estate advisory firm, said many building owners and investors are looking to restructure their loans and, in some cases, look for new capital. He said there was. However, in most cases, the sector is in decline due to lower utilization rates and higher borrowing costs.
“I feel like lenders are really recognizing the fundamental problem, which is that interest rates are going to stay high, which means there's going to be less capital to buy property, and fewer buyers are going to buy property. “That means the price will reflect that because there's less demand,” Seydlitz said. “And until we get stability, it just spirals accordingly.”
Last month, New York Community Bank's disclosure of unexpected losses on real estate loans related to office and apartment buildings heightened concerns about commercial real estate and sent the company's stock price plummeting. Treasury Secretary Janet L. Yellen acknowledged at a Congressional hearing in February that the sector could pose financial risks and said regulators were watching for signs of trouble.
A municipality's risk is determined by the extent to which its tax base depends on income from commercial real estate.
A Moody's Investors Service report last October found that Atlanta and Boston's credit ratings are among the most vulnerable to fluctuations in commercial real estate prices, but that the sector's upheaval will be a major factor for large cities in the coming years. He said it would be a threat.
“The shift to work away from the office, coupled with the existing trend of increased online purchases, is moving a significant amount of spending away from business districts,” Moody's analysts said in a report. .
Thomas Blossie, a research fellow at the Urban Institute's Tax Policy Center, said valuations are declining as rents for new properties become cheaper and owners challenge tax assessments when other buildings sell at lower prices. He pointed out that declines in prices tend to be a “lagging indicator.” He suggested that within the next three years, cities will have to make difficult choices about spending cuts and tax increases.
“It's going to get tough,” he said.
Major urban centers are already preparing for the worst.
San Francisco has been forced to postpone maintenance on city facilities to save money as tax assessment claims for commercial buildings skyrocket. Peskin, who is considering a run for San Francisco mayor, said he has pushed for policies that encourage the conversion of vacant office space downtown into apartment buildings.
New York City's auditor last summer painted a “doomsday” scenario in which city office values settled at 40 percent below their pre-pandemic peak. This translates to a budget shortfall of approximately $322 million in 2025 and approximately $1.1 billion in 2027.
In Washington, the office vacancy rate will exceed 20% by the end of 2023, and the financial situation is dire. Some upscale office buildings in the capital are adorned with signs advertising rental deals, but downtown retail space is deserted.
The owners of the Washington Wizards and Washington Capitals are looking to vacate the city's Capital One Arena and move the teams to Virginia, leaving a downtown area already struggling with restaurant and retail closures. It could cause further damage. The DowntownDC Business Improvement District business group estimates the arena helps generate $341 million in spending annually.
Glenn Lee, the city's chief financial officer, predicted last year that Washington would face a $464 million budget shortfall from 2024 to 2026, with much of the difference due to a decline in commercial real estate tax revenue. He said it was a thing. In an update last month, Lee warned that the industry's health is worse than previously expected and that changes in demand for office space could have a lasting impact on Washington.
“As more people work from home, the borough's transportation and office real estate sectors are likely to experience significant changes,” Lee said in a letter to the mayor and city council president about the capital's finances. . “Fewer commuters could reduce demand for public transport and office space, leading to lower property prices.”
He added, “Overall, the pandemic and the transition to remote work will likely have a broad economic impact on the District.”
