The Federal Reserve’s announcement on Wednesday of another ¾ point interest rate hike continues the central bank’s dark war on inflation. Higher rates cause damage to the whole economy, which never stabilized after the shock of COVID-19. But commercial real estate, vital to the economic and fiscal well-being of cities, has yet to be hit hard.
Ever-higher interest rates are slowing down the economy, and if the Fed continues to do so, it will cause a recession (which seems to be its goal). strongly in reaction to Powell saying it was “premature” to consider suspending increases, saying “we have a ways to go”. This does not bode well for the economy, nor for jobs and demand, nor for commercial real estate.
Cities and urban experts are particularly worried about the impact on commercial real estate, which has still not recovered from the COVID-19 pandemic. This has induced an increase in working from home (WFH) and a parallel decline in office occupancy, and there are signs that these impacts are becoming somewhat permanent. The much-watched Kastle Office Occupancy Barometer, which measures key card reads in ten major real estate markets, has slowly increased, but the ten city average still hasn’t topped 50%.
Jonathan Ponciano of Forbes points out that the Fed has now pushed interest rates to their “highest level since the Great Recession”. Fed reacts to continued high inflation, though many economists say inflation is fueled by factors beyond the Fed’s control, including war-induced food and energy price hikes aggression by Russia in Ukraine.
The Fed-induced slowdown put downward pressure on office building rents and also cast a shadow over future office construction. Cities depend on office labor to provide jobs, both directly and for lower-paid workers who provide services such as restaurants, security and cleaning. The office sector also pays taxes, rents to landlords and interest payments to banks.
These pressures on trade offices worry many observers. Some researchers are predicting a commercial real estate ‘apocalypse’, seeing downward pressure on property values and cheaper, shorter-term leases reflecting reduced demand as landlords scramble to find tenants. Their analysis for New York City predicts “long-term office valuations 39.18% lower than pre-pandemic levels,” which could lead to a “catastrophic fiscal loop” for city budgets.
It’s not just academics who are worried. In August, the Federal Deposit Insurance Corporation (FDIC) noted concern about banks with large concentrations of commercial real estate (CRE), and said examiners “will focus more on CRE transaction testing,” particularly new loans and bank balance risks. sheets.
So far, we are not witnessing a collapse of the CRE. On the one hand, there is downward pressure on house prices because, as Eliot Kijewski of Cushman and Wakefield points out, “the inability of buyers to access credit at interest rates once historically down cools the investment market”.
But loan repayments are not collapsing. The Mortgage Bankers’ Association reports that third-quarter delinquencies on commercial and multi-family loans actually fell slightly, part of a downward trend in 2022. Retail and accommodation loans continued to decline. be the worst, but even there the delinquencies are decreasing.
Delinquencies aren’t getting worse because tenants’ rent payments haven’t collapsed, allowing landlords to pay their borrowing costs. CommercialEdge reported that average office rents in September were down “2.4% year over year”, with many geographic and sector variations – no increase, but no slump.
There is anecdotal evidence that clients are looking for premium Class A office space, although they may leave less desirable existing offices. These older, less modern offices they are leaving are the big concern for the sector and for the cities.
Commenting on some positive moves by major New York companies into expensive new Class A offices, the New York Post quoted Savills’ Jeff Peck saying “the subtext is who’s going to absorb the spaces they’re leaving?” He noted that the economic difficulties of less affluent tenants will lead to demand for reduced rents and that “will cause real pain for these less class B buildings”.
This is the core commercial real estate and city budget problem of the Fed’s recessionary campaign. Small businesses and nonprofits will stop growing or shrink (or go out of business) during a recession, reducing demand for their office space. Some of these older buildings can be repurposed as residences, but this process takes time and requires more nimble policies from cities to encourage the transition.
And as Powell noted, the Fed is probably not done with raising rates and pushing for a recession. This will lead to loss of jobs, businesses and general well-being, with the impacts being felt hardest by low-income and vulnerable workers, and disproportionately on blacks and other minorities.
So we don’t have a commercial real estate “apocalypse” yet. But Fed pressure for a recession means cities and the commercial office sector are set to fall further.