Looking for signs the U.S. economy can continue to stave off a recession? Avert your gaze from commercial real estate. City office buildings are in trouble. For a century, the towers have been propped up by two pillars. One, workers filling the buildings all week. Two, money flowing freely in the form of loans to borrow, buy, and build. Those days are over. As hybrid work hardens from trend to new normal, office occupancy rates have hit all-time lows. Meanwhile interest rates have spiked to historic highs… and now the mortgage comes due: $1.5 trillion in commercial real estate loans expire in the next two years. It's enough to make you rethink the future of cities. We criss-crossed Manhattan, talking to players big and small, about a sector rocked to its foundations.
What is New York City without its skyline? Monuments to commerce, standing proudly shoulder-to-shoulder. More office space than any city in the world. But peek inside all this vertical real estate and there's a fundamental question. Where IS everyone? More than 95 million square feet of New York office space currently unoccupied - the equivalent of 30 Empire State Buildings.
Scott Rechler: This building had a lot of law firms, had some government tenants…
Scott Rechler is CEO of RXR, a New York real estate company with more than $20 billion in holdings. We walked through his property at 61 Broadway, near Wall Street. Every other floor—half the building—lies empty.
Scott Rechler: I think this is an existential moment. You know, I call it crossing the chasm
Jon Wertheim: What's the chasm specifically?
Scott Rechler: This post-COVID world of higher interest rates, the changing nature of how people work and live. We're not going back to where we were. It's a different world. And it's gonna be turbulent.
It already is. The return to office has stalled out: Fridays are dead. Mondays aren't much busier. As tenants shrink their office footprint, office landlords are confronting the fact that some of their buildings have become obsolete, if not worthless…Ever the pragmatist, Rechler decided not to throw good money after bad at 61 Broadway, and defaulted to his bank on a $240 million loan.
Jon Wertheim: I could see people saying, "that's a lot of money. How did he sleep last night?"
Scott Rechler: We invest a lot of equity. If it works, we make a lot of money. If it doesn't work, the lender-- can take over the building. You gotta face reality, right? Reality's coming your way.
The reality is the price of office buildings is tanking, as much as 40% since the pandemic. Uptown at Columbia Business School, Stijn Van Nieuwerburgh, a professor of real estate, has modeled out the impact of hybrid work on pricing…and calls it a train wreck in slow motion.
Prof. Stijn Van Nieuwerburgh: And this is just the beginning. And the reason it's just the beginning is because there's a lot of office tenants that have not had to make an active space decision yet. "Do I want to renew this space? Do I wanna vacate? Maybe I sign a new lease for half as much space." This is what tenants have been doing for the last three years. So when you take all of those current and future declines of cash flows into account, we end up with about a 40% reduction in the value of these offices.
Consider this office building near Penn Station - one of a handful of sales in the city last fall. Built in 1920 and showing its age, eight empty floors with a 99-cent store on the ground level.
Real estate partners Tony Park and Elad Dror, told us they'd been eyeing that building for years, and, pre-pandemic, offered the owner $80 million. They didn't get very far.
Tony Park: He doesn't answer.
Jon Wertheim: He didn't even answer you guys?
Tony Park: He didn't answer, (laugh) yeah. We didn't have his attention, at all.
Jon Wertheim: So what do you think happened?
Tony Park: The whole building is now empty.
In September, Park and Dror got the building for less than half their original offer. And they have plans to convert the place.
Jon Wertheim: Did you ever think of just keeping it as an office building?
Tony Park: No. Never.
Jon Wertheim: You laugh.
Tony Park: Anything that is not an office.
