A lot of professional organizations are coming to realize what we figured out many years ago: Working from home has a lot of challenges, but also a tremendous amount of benefits. One benefit we have long enjoyed is, by not requiring someone to move, we are able to recruit the best people to be part of our team. Another is not having to burden our nonprofit budget with paying monthly office rent. The sweetener is that we spend some of that savings getting together two or three times a year, always someplace enjoyable, usually accompanied by churros and thrill rides.
But we’re a small operation with a tiny budget. I know people working tech in downtown San Francisco, people whose employers have long insisted they come into the office daily, people who are now working productively from home. Those employers are watching their workforce maintain (or even increase) production levels while they simultaneously pay millions in rent on empty buildings.
More than a few people are speculating how this period of quarantine will change how we work. Few things are certain, but it’s difficult to imagine it increasing demand for office space.
That’s interesting because, heading into this pandemic, we already had a glut of commercial space. In 2017, there was an interesting piece from Greater Greater Washington on the glut of vacant office space in Washington DC. The article lamented why, in a city with explosively high housing prices, some of the 14 million square feet of vacant commercial space could not—or was not—being converted for residential use.
If half of it was converted to 1,200 square foot units, that would be around 5,000 new units. According to the same site, that is more units than were permitted to be built in DC in the prior year. This seemed an easy and obvious way to address the demand for more housing.
. . .
What Comes Next for Commercial Real Estate
We’ve centralized the finance of local real estate transactions and made our markets less responsive to local conditions because it was an efficient way to pump money into the system. It was an easy way to create jobs, growth, and economic development. It was an easy way to drive up real estate prices, which benefits nearly everyone involved. In short, our desperate pursuit of inflation as a proxy for a real economy created a bubble in commercial real estate.
The dramatic slowdown of life in response to the Covid-19 pandemic has popped that bubble. We’ve seen how many corporate tenants have already stopped paying their rent, threatening the entire finance model. Billions in bailout dollars were aimed at this part of the market. The Federal Reserve is buying commercial real estate and corporate bonds in a desperate attempt to keep their prices stable. This is all an attempt to buy time in the hopes that things turn around soon. The cries you hear about restarting the economy use small business and the poor as their rally, but this is all about keeping the tear in the many bubbles we’ve blown from expanding.
The longer this goes on, the more businesses that will opt to not pay their rent. That’s not a dumb move since it’s not like a landlord can go through the eviction process with the hopes of quickly securing another tenant. Many landlords will find themselves with no income on properties that have ongoing cash demands. These are the weakest players and it won’t take them long to be forced into liquidation. This will start to happen in months, not years, although the properties could sit empty for years as tangled and interwoven claims are worked out.
The greatest drama is playing out with those properties unfortunate enough to have their loan expire during the next twelve months. We will undoubtedly find some creative ways to “extend and pretend,” and it’s almost certain that the federal government will try to bail out this system by lowering rates, extending payback terms, and guaranteeing loans. Even so, there is going to be a reckoning based on the reality that market participants — the tenants in those buildings — will not be able to afford pre-crash rates of rent.
Remember, if the rent drops, the value of the property drops. Even with a long feedback loop, that’s the constraint that can’t be avoided. Lower rents destroys the commercial real estate market along with your pension fund (as I wrote a year ago) and a whole bunch of other supposedly safe investments that were chasing higher returns. This is going to be painful, and I suspect we’ll do everything we can to blow more bubbles and try to avoid this pain.
Yet, our small businesses need lower rents. Our commercial property owners need more flexibility in how they respond to local needs. This adjustment is acutely painful, no doubt, but let’s understand that it is fixing a chronic problem that has also grown deeply painful for a broad spectrum of society.
We desperately need to get off this roller coaster, to stop inflating and then reinflating a series of financial bubbles. The reckoning we sought to avoid has arrived. Our conversation needs to shift from preventing damage to setting ourselves up for the quickest recovery. How do we use our limited resources to seed the next generation of small businesses and entrepreneurs? How do we help them get back on their feet the quickest?
We can spend billions bailing out commercial real estate investments that have lost all touch with reality, or we can spend a small fraction of that keeping our local businesses on life support, allowing them to emerge after this financial disaster (of our own making) in position to thrive in a marketplace cleared of the unfair subsidies and advantages long given their corporate competition. That’s how we respond to local needs. That’s how we salvage something from this mess.
The urgent lead to localize is upon us. It’s only going to get crazier unless we shore up the foundation of our economy. We need to start building strong and resilient places. We need strong towns.
Random stuff I find interesting and you may not.
