In San Francisco, a 20-story office tower sold for $146 million a decade ago was listed in December for just $80 million.
In Chicago, a 200,000-square-foot office building in the Clybourn corridor that sold in 2004 for nearly $90 million was purchased last month for $20 million, a 78 percent discount.
And in Washington, a 12-story building combining offices and commercial spaces three blocks from the White House, sold for $100 million in 2018, was recently sold for only $36 million.
Such deep discounts have become normal for office space in the United States, as pandemic trends of hybrid and remote work persist, emptying urban centers that were once teeming with workers. But the losses aren’t just affecting commercial real estate investors. Cities are also starting to bear the brunt, as municipal budgets that rely on taxes associated with valuable commercial properties are now facing deficits and considering reductions as lower property value assessments reduce tax bills.
«They’re being sold at deeply discounted prices,» Aaron Peskin, chairman of the San Francisco Board of Supervisors, said of his city’s office buildings. “If you were the ones buying at the top of the market, you would be in for a huge haircut.”
Mr. Peskin said San Francisco’s $14 billion budget is at risk of being $1 billion short in the next few years, in part because of lost commercial real estate tax revenue.
“In the short term, this means less money in municipal coffers and a less robust downtown,” he said.
Since the pandemic, cities across the country have benefited from an economic rebound and an infusion of billions of dollars in federal aid disbursed as part of the 2021 American Rescue Plan. This has left municipalities so full of money they gave raises to municipal employees. , renovation of local basketball and tennis courts, and improvement of sewer systems.
But now budgets are starting to tighten.
A budget report released last year by the National League of Cities found that optimism among municipal finance officials was beginning to wane amid concerns about falling sales and lower property taxes coinciding with the expiration of funds federal.
The cuts could lead to what Arpit Gupta, a professor at New York University’s Stern School of Business, described as an «urban doom loop» across the United States.
In a research paper updated late last year, Mr. Gupta and his colleagues estimated that the domestic office market lost $664.1 billion in value between 2019 and 2022. To fill the holes budget created by lost tax revenue, they posited that cities could cut services or raise other types of taxes. But that would have its own downsides, including incentivizing businesses and residents to leave, making the problem worse by further eroding the tax base.
Mr. Gupta likened this dynamic to the dilemma that Rust Belt cities faced in the 1960s and 1970s, when manufacturers closed their doors and local governments struggled to balance their budgets.
“Some cities that have tried to raise taxes and cut public services have found that these responses have accelerated the process of urban exodus,” he said. “It kind of got worse.”
The strains weighing on the commercial real estate industry have been evident since the pandemic accelerated the trend toward remote work. That has been complicated by high interest rates, which have made refinancing costly, and by strains in the banking sector, which holds about $3 trillion in outstanding commercial real estate debt.
This situation is reminiscent of the upheavals experienced by the commercial real estate sector during the 2008 financial crisis, when credit dried up. This time, however, changes in how and where people work suggest that a deeper structural shift in the market may be taking hold – at least until interest rates fall.
Glen Seidlitz, principal and founder of Washington-based commercial real estate consulting firm Six23, said many building owners and investors are trying to restructure their loans and, in some cases, are seeking new capital. But for the most part, due to falling occupancy rates and rising borrowing costs, the sector is in decline.
«It feels like lenders are really recognizing the fundamental problem, which is that if interest rates stay higher, that means there’s less capital to buy property and if there’s less buyers to purchase real estate, prices are obviously going to reflect lower demand,” Mr. Seidlitz said. “And so until there is stability, there will just be this spiral that happens based on that.”
Concern over commercial real estate grew last month when New York Community Bank revealed unexpected losses on real estate loans tied to office and apartment buildings, sending its shares plunging. At a congressional hearing in February, Treasury Secretary Janet L. Yellen acknowledged that the sector could pose financial risks and said regulators were watching for signs of trouble.
The risks for municipalities depend on the dependence of their tax bases on commercial real estate revenues.
A report from Moody’s Investors Service last October said the credit ratings of Atlanta and Boston were among the most vulnerable to fluctuations in commercial real estate prices, but that upheaval in the sector would pose a threat to large cities in the coming years.
“The shift to more work outside the office, compounded by the pre-existing trend toward increased online shopping, has removed a substantial share of spending from business districts,” Moody’s analysts said in the report.
Thomas Brosy, a research associate at the Urban Institute’s Tax Policy Center, noted that declining assessments tend to be a «lagging indicator» as new leases get lower rents and landlords appeal tax assessments when other buildings are selling at low prices. He suggested that over the next three years, cities will have to make tough choices about cutting spending and raising taxes.
“It’s going to start to hurt,” he said.
Major metropolitan centers are already preparing for the worst.
San Francisco, which is experiencing an increase in tax appeals for commercial buildings, has had to postpone maintenance of municipal facilities to save money. Mr. Peskin, who is considering a run for mayor of San Francisco, said he has pushed for policies that would encourage the conversion of vacant downtown offices into apartment buildings.
New York City’s comptroller presented a «doomsday» scenario last summer in which the value of the city’s office space would be 40% below its pre-pandemic peaks. This would result in a budget deficit of about $322 million in 2025 and $1.1 billion in 2027.
In Washington, where the office vacancy rate exceeded 20% at the end of 2023, the budgetary situation is also dire. Signs announcing leases are plastered on some of the capital’s most prestigious office buildings, while downtown commercial spaces remain empty.
The owner of the Washington Wizards and Washington Capitals plans to leave the city’s Capital One Arena and move the teams to Virginia, which could deal another blow to a downtown already struggling with the closure of restaurants and bars. retail stores. The DowntownDC Business Improvement District business group estimates the arena helps generate $341 million in annual spending.
City Finance Director Glen Lee projected last year that Washington would face a $464 million budget shortfall between 2024 and 2026 and attributed much of that gap to declining state tax revenue. commercial real estate. In an update last month, Mr. Lee warned that the health of the sector was deteriorating more than expected and that changes in office demand could have lasting consequences for Washington.
“As more people work from home, the District’s transportation and office real estate sectors will likely experience significant changes,” Mr. Lee said in a letter to the mayor and city council president about the finances of the capital. “With fewer commuters, there could be less demand for public transport and offices, which could lead to a reduction in property prices.”
He added: “Overall, the pandemic and the shift to remote work will likely have significant economic consequences for the District. »