Lots of offices are still empty – and they’re becoming a huge risk to the economy

The next big potential risk to the US economy may be lurking in corporate towers across the country’s downtown areas.

With so many people still working from home, companies are reducing office space to the point that it threatens to create more headwinds for the US economy.

The disintegration of the office sector is causing trouble not only for banks with nearly $1.2 trillion in outstanding office loan debt, but also for countless small businesses that rely on white-collar clients as well as cities that benefit from the associated property taxes. office buildings.

It’s a worrying development for the commercial real estate industry at a time when the US economy is already showing signs of stress and possibly recession.

Here are some of the ways America’s empty offices could further hurt the economy:

Landlord defaults and foreclosure

Almost 20% of office space is currently empty across the United States. It’s a milestone that exceeds the rate of job vacancies during the 2008 global financial crisis, and it’s worse in places like San Francisco and downtown Los Angeles, where more than a quarter of offices are vacant.

If companies continue to forego leases, and if demand for office space remains sluggish, landlords will not be able to collect the rents needed to keep up with mortgage payments to pay down business loans, according to analysts.

Many of those loans are due next year, and building owners will need to refinance their debt at a time when declining occupancy has eroded building values ​​and soared interest rates.

This means that many landlords may soon experience steeper payments.

Analysts say it could end badly.

“I would say the first implication would be defaults and foreclosures,” says Kenneth Rosen, president of real estate research firm Rosen Consulting Group.

Banks will also feel the pain

Rising defaults and foreclosures are likely to send tremors throughout the US banking system.

The bulk of the $1.2 trillion in office space debt is owed to smaller regional banks, which are already in turmoil from depositors fleeing to the larger ones.

Over the past two months, three smaller banks have failed. This problem has continued to run rampant as PacWest Bancorp shares took a hit last week.

If office owners can’t honor their loans and eventually hand over the keys, banks will need to find new buyers, a difficult task when interest rates are high, credit is shrinking and concerns about the economy are growing.

It all happened attention of policy makers.

In a report published Monday, the Fed said it has increased and broadened its scrutiny of commercial real estate loans and the banks that issue them in general.

The fallout could upend city centers

Soaring vacancies are already upending the ecosystems of downtown city centers.

Dry cleaners, shoe removers, restaurants and shops that have long relied on foot traffic five days a week are struggling to survive.

“Right now, I probably get 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% from what they were before the COVID-19 pandemic. “I’m here now starting again to see if it still works, but I don’t know.

For public transportation systems, fewer travelers and the end of pandemic-related aid are contributing to budget deficits and projected massive deficits.

And for local governments, high-level vacancies will mean a drop in property tax revenue, which will punch a hole in the city’s finances.

The owners are desperately looking for solutions

The commercial real estate market has a few good options.

Some realtors are exploring ways to convert their office buildings into apartments, which could help alleviate the housing shortage, but not all buildings can be converted smoothly without major alterations and expensive reconstruction, which is a big undertaking, given the tighter lending conditions and higher borrowing costs. .

Brokers and realtors are doing everything they can to get new occupants for their high-end buildings.

Cushman & Wakefield offers helicopter tours of new offices in downtown Los Angeles, built on a very expensive bet that high-amenity spaces with exciting restaurants, fancy fitness centers, on-site childcare and refreshing workspaces will be enough to lure companies and workers behind.

So far, the demand for those high-end spaces looks promising, but committing to them at a time of great economic uncertainty is a gamble, which analysts don’t think will be enough to save the overall office sector.

A safer solution is one that many workers seem unwilling to consider: ending telecommuting and a fully aggressive return to the office.

Barring that, cities and businesses that once thrived on white-collar workers will flounder—even fail—without them.