What $1 Trades Tell Us About the American Office Market

New York City deli owner Jimmy Yavrodi looks grim from the store he opened in New York City's prime commercial district 27 years ago.

“Everything is empty,” he says. “I do not understand.”

From his perch on Park Avenue South, the 61-year-old put two children through college, employed 12 people and handed out sandwiches and salads to office workers streaming in from nearby buildings. .

These days, it provides a window into what some are calling the American office “apocalypse.”

The nearby famous triangular Flatiron Building has been vacant since 2019, but its owners announced last fall that they would convert it into condominiums.

Around the corner, construction is underway on new offices facing Madison Square Park. But its anchor tenant, IBM, is being consolidated from other spaces in the city.

The property next door to his, 360 Park Avenue South, has been vacant for redevelopment since 2021. The 20-storey building, which sold for $300m (£233m) in the same year, recently saw one of its owners transfer a 29% stake to one of its partners and spend a further $45m on refurbishments. It became a hot topic for abandoning its promise to provide funding. in exchange for $1.

The area still has Michelin-starred restaurants, a steady stream of tenants, and even includes part of the state's court system.

On the streets, residents will tell you that life has returned to normal since COVID-19.

But sales at Yavrodi's Taza Cafe & Deli, which have fallen 70% since 2020, tell a different story. It reveals the enormous challenges facing office property owners across the country and the risks those problems pose to the broader economy.

“We rely on office workers, and office workers aren't here. It's very simple math,” he says. “If they don't come to work, places like ours can't survive.”

Four years after the pandemic revolutionized work-from-home practices, particularly in the United States, the changes are proving difficult to reverse, and their impact can no longer be ignored.

At the end of last year, about 20% of the nation's office space was rented, according to Moody's Analytics, and the vacancy rate was the highest in more than 40 years.

This number is expected to increase over the next 12 to 18 months, as reduced demand transforms urban neighborhoods and hurts real estate values, which are already down an estimated 25% across the country.

A recent paper estimates that more than $660 billion in value was lost in the United States between the end of 2019 and the end of 2022.

This decline has coincided with a sharp rise in borrowing costs, creating an incentive for even deep-pocketed companies to exit real estate as buildings are worth less than loan repayments.

The problem, which accounts for an estimated 44% of the country's office mortgages, has raised widespread concerns about how banks and the broader economy will absorb the impact as lending begins to deteriorate.

Financiers in countries as far away as Germany and Japan are hoarding hundreds of millions of dollars in anticipation of loan failures.

The problem is particularly acute among local and regional companies, and some, such as New York Community Bank, have already seen their stock prices plummet dangerously as investors flee from potential problems.

Analysts say the situation could spiral as banks fail or cut back on loans, making it harder for citizens and other businesses to obtain loans and leading to a deeper economic slowdown. ing.

In Washington this week, politicians pressed the head of the U.S. central bank about what officials are doing to avoid the worst.

“There will be losses,” Federal Reserve Chairman Jerome Powell told Congress, adding that regulators were in touch with companies to shore up their financial cushions. “I believe it's a manageable issue. If things change, I'll say so.”

Thomas LaSalvia, head of commercial real estate economics at Moody's Analytics, said many of the defaults so far have been strategic, reflecting changing investment priorities rather than financial distress.

He is one of those predicting local pain rather than global economic upheaval.

But the coming months will be a test, as many mortgages taken out before the U.S. central bank raised interest rates will need to be refinanced.

“That's the final part of this story that's going to unfold over the next six to nine months. It's when and how much pain we're going to actually suffer,” LaSalvia said.

“The office market…needs to right-size, and that's not done yet.”

Erika Jiang, a professor at the University of Southern California who co-authored a paper on bank failures, said the risks to the banking sector would be “much smaller” if interest rates were cut later this year, as most expect.

But even without an economic disaster, U.S. cities that often rely heavily on taxes from office real estate to fund libraries, parks, and other basic services have seen plummeting values ​​and reduced activity. They are feeling the effects because the income they depend on to do their jobs is threatened.

New York City, which expects office real estate to generate about 10% of its tax revenue, could face a shortfall of more than $1 billion over the next few years under a doomsday scenario, the auditor said last summer. I warned you.

He said that represents less than 2% of tax revenue and the city is likely able to adapt to the challenge.

But elsewhere the situation appears to be more serious.

In San Francisco, where the shift to remote work is furthest along, the mayor has ordered staff to pause hiring and prepare to cut spending by 10%.

Analysts in Boston, where more than a third of tax revenue comes from commercial property taxes, are predicting an impending budget shortfall and are urging the city to find new ways to raise money.

Alerts have also been issued in Atlanta, Dallas and other cities.

Moody's LaSalvia said the pandemic has accelerated the transition from downtown's 9-5 business district to mixed-use areas that has been in the works for decades.

Vacancy could pose a problem in the coming years, he said, but supply will shrink and falling values ​​will also create opportunities for new companies to come in and reinvent neighborhoods.

“This is a moment in time when the center of gravity of each of our cities shifts and the centers of power shift,” he says.

Yavrodi's neighborhood is perhaps one of the best positioned to weather this transition, with many businesses investing money to upgrade their facilities.

Across the street, a building recently rebuilt with city tax incentives is now almost fully occupied by a small health care company.

Next door, at 360 Park Avenue South, a restaurant and one company have committed to renting space, and owner Boston Properties expects the building to be nearly full again by the end of next year. said.

Although the high-tech companies that once drove demand in the area have left, Peter Turchin, vice chairman of real estate firm CBRE and the building's leasing agent, says there is still interest from financial and law firms. Financial and legal firms are ready to bring employees back to the office and pay for top-of-the-line space.

“I don't think it has any broader implications at all,” he says of the $1 trade. “We are very busy.”

The companies that sold the stakes that invest money in the Canada Pension Plan declined to comment.

Yavrodi remains skeptical.

Even if you rent space, it's estimated that only 12% of Manhattan office workers come to work in person five days a week.

He says that's not enough to sustain a retailer like his. Especially since so many companies rely on free or heavily subsidized food to make back-to-office orders easier to swallow.

After reducing his staff from 12 to five, changing his menu and expanding delivery, he doesn't think there's much anyone can do to address the issue.

“Everyone has different ideas, but if they need major stitches, they try to bandage the big cut,” he says.

“The office lifestyle we had before the pandemic will never return.”