The Implosion of Commercial Office Space Has Begun – Part 2

A negative outlook in the commercial real estate (CRE) market emerged from a combination of trends that include secular and cyclical ones, a liquidity crisis in the banking sector, and the wicked crime wave in certain major metropolitan areas. The secular trend is comprised of a steady increase in e-commerce sales that put pressure on brick-and-mortar retail and anchor department stores that are disappearing from shopping malls after having faced numerous challenges over the last decade or so. More recently, a post-COVID “work from home” (WFH) movement that’s permanent for a large percentage of the workforce is coming home to roost with enormous vacancy rates in commercial buildings and office space. The initial increase in vacant office space and a plunge in real estate investment trusts (REITs) was covered in Part 1 (Twitter thread) last spring:

“It can be difficult to find a bear among analysts in the commercial real estate market despite the fact that office vacancy rates continue to rise across the country and distressed mortgages for office buildings are at the highest level since the Great Financial Crisis (GFC). More than two years after COVID-19 transformed the world of work, there are signs of a slow-motion trainwreck taking place at your former office cubicle. The commercial market includes manufacturing space, warehousing operations, consumer retail frontage that occupies a variety of property types, and corporate office space. They all have their own dynamic and localized market variables vs. the national and local economies… The impact on real estate due to the pandemic is unprecedented and continuing. Folks who were a slave to the rat race commute, and a maze of office building cubicles are keeping their newfound WFH arrangements and flexible hybrid working models permanent. That phenomenon continues to transform how, where, and when we work if the job doesn’t require in-person labor or professional services. The exodus from large metropolitan areas in search of a better quality of life and/or a WFH paradise contributed to a sellers’ market and the growing unaffordability of residential real estate.” – TraderStef, May 2022

The current downturn in the economic cycle stands out due to the Federal Reserve’s unprecedented speed of interest rate hikes since March 2022 following its abrupt flip to hawkish quantitative tightening (QT) monetary policy. The CRE market is particularly vulnerable because it thrives on stable cash flows and relies heavily on debt financing. Making matters worse is the sudden shock of a banking crisis that’s pressuring institutions to pull back on lending and tighten standards. Since the CRE market is underpinned by debt, a financing gap is surfacing that needs to be filled. The current economic downturn and issues facing the CRE market were covered in “The Recession Arrived With Wardogs and Goldilocks’ Hopium in 2023” Part 1 and 2 (ongoing thread) and “#TaperCaper Realized Amidst Silicon Valley Bank Implosion” Part 1 and 2 (thread).

An extraordinary crime wave with brazen shoplifting and smash-and-grab mob heists has become a regular occurrence that’s forcing major retail chains and Main Street entrepreneurs to close up shop and exit crime-ridden metropolitan hellholes.

Theft wave and organized smash-and-grab shoplifting show California law needs change… “If any California proposition of the last half-century is an obvious candidate for a major rewrite, it is the 2014 Proposition 47, which made it a small-time offense to steal anything worth less than $950, unless you have a history of violent crimes… Many police say this law is a major factor in the wave of shoplifting that has plagued cities like San Francisco and Los Angeles and closed many stores. They also blame it for so-called ‘smash-and-grab’ heists… At the same time, because some felonies suddenly became misdemeanors, police and prosecutors started simply arresting, booking and releasing defendants when a crime involved less value than $950. This went without much fanfare until the smash-and-grab crimes highlighted the weaknesses of Prop. 47.” – Desert Sun, Jan. 2023


Some Big Cities Need to Get a Grip on Crime… “Anyone who’s been paying attention knows that you’d have to be a confirmed masochist to try to open a business or a new store in the central business districts in a number of the largest cities in the United States. Ground Zero these days for urban unrest and the constant dashing of good intentions is undoubtedly San Francisco, where even foolishly optimistic corporations like Whole Foods have basically given up fighting against the continued assaults on their people, non-stop and largely tolerated shoplifting and overt thefts, open-air drug markets, and mentally ill homeless people wandering the streets. Only weeks after Whole Foods shuttered a nearly brand-new store in San Francisco, Nordstroms, a longtime and legendary retailer, announced that it is closing two downtown locations as well. Seattle and Portland, Oregon, don’t even pretend any longer. Their streets, sidewalks and parks are virtual war zones and no one running any kind of business there thinks they’re going to be able to survive much longer. Street crime and drugs are rampant and basically ignored by the progressive municipal administrators, and the disease is spreading. We’re seeing the same kinds of issues and problems in Chicago, and we also have insane levels of carjackings by armed groups of 13-year-old kids. In addition to the retail marketplace collapsing in downtown and commercial real values plummeting, we’re seeing a growing exodus of major corporations, which has even worse implications for the city’s long-term health and viability.” – Inc., May 9

Taken together, commercial real estate values are falling due to an imbalance between supply and demand, higher financing costs, and a deteriorating economy that lacks law and order in major cities. U.S. banking lenders are warning that the CRE market is the “next shoe to drop.”

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Commercial Real Estate Faces Perfect Storm: The Demise of Downtown Office Buildings… “Three years after the onset of the lockdowns in Toronto, many offices remain half empty. The pre-2020 crowds who ate and shopped in the underground area beneath the towers are far smaller. In fact, before the lockdowns the underground was overcrowded to the point of being an introvert’s worst nightmare. The changes in the Toronto Financial District mirror the story of most downtown cores of major cities across North America, if not the industrialized world.” – Epoch Times, Mar. 25


Executives and investors fret about impact of rising rates and empty buildings on $5.6T market… “Rising interest rates, falling prices and waning demand for office space following the pandemic had strained the commercial property market. But these troubles intensified after this year’s failures of Silicon Valley Bank, Signature Bank and First Republic raised worries about other regional banks that account for the bulk of commercial real estate loans. ‘The private market hasn’t started to heavily mark down real estate,’ Apollo Global Management co-president Scott Kleinman told the Financial Times. ‘The equity will be first. That’s the next shoe to drop in the US. Like everything else, it has been priced so tightly and there hasn’t been a commercial real estate crisis in the US since the ‘90s.’ Guggenheim Partners chief investment officer Anne Walsh said the pain would be concentrated in certain regions of the US, including large urban centers such as San Francisco and New York, as well as in second-class office buildings that are in need of repair. ‘We’re likely going into a real estate recession’… Walsh noted some lenders were requiring personal guarantees from property owners — in which borrowers pledge their own assets to secure a mortgage — a signal of the tightening lending standards and the fact that banks were pulling back.” – Financial Times, May 9



Commercial Real Estate Next Shoe to Drop Amid Banking Crisis - JPM via MrTopStep

JPMorgan Survey Courtesy of MrTopStep, Apr. 2023


Empty CRE is a major problem. It’s estimated that no rent is being paid on at least 20% of all U.S. office space, and small banks financed approximately 70% of those loans. As cash flow and liquidity continue to dry up, there will be a significant increase in loan defaults that can wipe out the banking institutions that financed them.

Rent Not Being Paid on 20% of all U.S. Metro Office Space - Joe Consorti

Rent Not Being Paid on 20% of All U.S. Metro Office Space – Joe Consorti


The CRE implosion not only impacts the financial industry, urban commerce, and wider economy but will also accelerate the housing bubble bust that’s covered in “Bubble, Bubble, Housing Market Toil and Trouble” Part 1 and 2 (thread). As of 1Q23, San Francisco home prices are down 33% YoY, and the city has lost 7% of its population since 2020. Prices in the Bay Area are down more over the last 10 months than the first 10 months of the GFC. The office vacancy rate is roughly 30%, with 30 million square feet sitting empty. A downtown office tower that was worth $300 million four years ago failed to attract buyers but is expected to sell at an 80% fire-sale discount for $60 million. San Francisco is dead. The Union Bank Plaza 40-story office building in downtown Los Angeles reportedly sold for $105 million, a 50% discount from its $208 million selling price in 2010.

San Francisco Office Vacancy Rate 2000 - 1Q23

San Francisco Office Vacancy Rate 2000-1Q23 – Kobeissi Letter


Cellphone Activity in Major U.S. Cities Post-Pandemic

Cellphone Activity in Major U.S. Cities – Statista, Apr. 2023


Office building credit crunch could hit wider U.S. economy, former Deutsche Bank property lender says… “‘Every single crisis in my lifetime has been headlined by real estate,’ says Toby Cobb, co-founder and managing partner of 3650 REIT… Cobb was Deutsche Bank’s co-head of U.S. commercial real estate in the run up to the global financial crisis of 2008… He now thinks office woes could put other areas of commercial-real estate at risk of contagion, and that the U.S. could be headed for a meaningful economic downturn, as banks pull back from lending because they end up reeling from their office exposure… Like with the glut of U.S. malls plaguing the retail sector for years, Cobb expects home offices to exacerbate the office problem. ‘I don’t think people are talking about this,’ he said… Jones Lang LaSalle estimated that 20% out of about 4.8 billion square feet of existing U.S. office space was vacant in the first quarter of 2023.” – MarketWatch, Apr. 27


A $1.5 Trillion Wall of Debt is Looming for US Commercial Properties… “Almost $1.5 trillion of US commercial real estate debt comes due for repayment before the end of 2025. The big question facing those borrowers is who’s going to lend to them? ‘Refinancing risks are front and center’ for owners of properties from office buildings to stores and warehouses, Morgan Stanley analysts including James Egan wrote in a note this past week. ‘The maturity wall here is front-loaded. So are the associated risks.’ The investment bank estimates office and retail property valuations could fall as much as 40% from peak to trough, increasing the risk of defaults.” – Bloomberg, Apr. 8

Buckle up and be sure your homestead and financial house are in order.

Patrick Carroll: “It’s going to be ugly, as bad as the GFC.” – CNBC, Apr. 13


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The Implosion of Commercial Office Space Has Begun – Part 2

The Implosion of Commercial Office Space Has Begun – Part 2