The next crisis will start with empty office buildings

Commercial real estate is losing value fast. "I'm going to cancel all my zoom meetings." It was May 2021, and Jamie Dimon had had enough. The JPMorgan Chase CEO expected the company's office to "look the same as it did before" in September-October. In two years, his company will have reduced its Manhattan presence by a fifth.

Postpandemic, kids are back in school, retirees are on cruises, and physical stores are doing better than expected. But offices are struggling, perhaps more than many superficial observers realize, and the consequences for landlords, banks, municipal governments and even individual portfolios will be tangible. In some cases, they will be catastrophic. But''This crisis, like all crises, also represents an opportunity to rethink many of our ideas about work and cities.

Office vacancy

In the first three months of 2023, office vacancy in the U.S. surpassed 20 percent for the first time in decades. In San Francisco, Dallas and Houston, vacancy rates are as high as 25 percent. These numbers underestimate the severity of the crisis because they only cover spaces that are no longer leased. Most leases were signed before the pandemic and are not yet up for renewal. Actual office utilization indicates a further decline in demand. Attendance in the 10 largest business districts is still less than 50 percent of pre-COVID levels because white''collar workers spend approximately 28 percent of their workday at home.

With a third of all office leases expiring by 2026, we can expect higher vacancy rates, significant rent reductions, or both. And as we grapple with the effects of distributed work, artificial intelligence could further reduce office demand. Some experts point out that the most expensive offices are still doing quite well, and that others could be saved by introducing new amenities and services. But landlords can't rent all the empty Louis Vuitton and Apple retail stores. There simply isn't enough demand for such space, and new features make buildings even more expensive to construct and''exploitation.

Financial implications

With such bleak prospects, some landlords are threatening to "give the keys back to the bank." Over the past few months, real estate giants RXR, Columbia Property Trust, Brookfield Asset Management and others have collectively defaulted on billions of dollars in commercial loans. These defaults are partly an indication of real problems and partly a play on relationships. Most commercial loans were made before the pandemic, when offices were busy and rates were low.

The current situation is much different: high vacancy rates, doubled interest rates, and nearly $1.5 trillion in loans due by 2025. Defaulting now allows''landlords to use their remaining influence to advocate for loan extensions or proceeds. As John Maynard Keynes observed, when you owe your banker $1,000, you are under his power, but when you owe him $1 million, "the situation is reversed. "

Implications for cities

Municipal governments have even more reason to worry. Property taxes are the backbone of city budgets. In New York City, such taxes account for about 40 percent of revenues. Commercial real estate, mostly offices, accounts for about 40 percent of these taxes or 16 percent of the city's total tax revenue. San Francisco has a lower share of property taxes, but offices and retail appear to be in''even worse.

The empty offices are also contributing to declining retail sales and public transportation use. In New York City, weekday subway rides are at 65 percent of 2019 levels, though they are rising, and public transit revenues are down $2.4 billion. Meanwhile, more than 40,000 retail jobs lost since 2019 have yet to return.

Rethinking perceptions of jobs and''

Many cities face difficult choices. If they cut certain services, they may become less attractive and trigger a possible "urban cycle" that will drive away even more people, hurt revenues and support a cycle of decline. If they raise taxes, they could drive away wealthy residents who are more mobile now than ever. Residents earning $200,000 or more contributed 71 percent of income taxes in New York State in 2019. The loss of wealthy residents to low-tax states like Florida and Texas is already affecting New York and California. Both states' revenue bases have shrunk by tens of billions since the pandemic began.

The turmoil in office markets is threatening pension systems and''portfolios of individuals. Public and private pension funds have traditionally invested their assets in stocks, bonds and cash. In recent decades, however, they have shifted to so-called alternative investments, including commercial real estate and private equity. These investments now make up a third of their portfolios, with commercial real estate making up more than half of these assets for many pension funds.

You get the idea. Office buildings pose a threat to a variety of financial institutions. As leases expire and loans mature, much of the pain is still ahead. Over the next two years, many city centers will find that dozens of buildings are no longer suitable for''destinations. Municipal services are likely to deteriorate and more people may leave. The worst-case scenario is a return to the 1970s with bankrupt municipal governments, rising crime and an exodus of (mostly white) middle-class residents. Landlords like to point out that "New York City always comes back." But some cities, like Detroit or Pittsburgh, have never recovered from previous waves of technological change. And even in New York, recovery can take decades.

In the '90s, the internet helped cities recover. As the economy became increasingly dependent on innovation and creativity, many of the largest and most dense city centers flourished. In 2007, one of the leading urbanists''world Ed Glaser called it "the central paradox of our time" that cities remain "unusually vibrant despite the increasingly easy movement of goods and knowledge". Economists continued to explain this paradox until the current crisis. According to the theory, companies require the rapid exchange of ideas and specialized division of labor that large cities provide. In addition, companies want access to the most skilled labor, and top professionals like living in big cities because of the lifestyle.

The consensus among economists was that with the rise of technology and media, economic activity would be concentrated in a few super cities. But even before COVID, the theory began to crack as some of''s leading cities shrank in population, tech giants began spreading their offices to smaller cities, and the office market was fueled by the irrational, venture capital-funded expansion of WeWork.

The pre-COVID consensus was not wrong, but leading thinkers failed to consider the full implications of their own theories. Once the quality of online collaboration became key, the Internet itself became the largest pool of talent and the primary means of communication between people. And once highly educated people were able to make good money anywhere, lifestyle preferences became more diverse. This doesn't mean that supercities are doomed, but it does mean that their early