The Crisis in Commercial Real Estate

How it could affect all of us…

Commercial real estate seems to be going through a major and prolonged paradigm shift. Culturally, we are fundamentally changing how we interact with offices, retail stores, restaurants and small businesses. As with any re-alignment, there is likely to be pain. How could that affect your wallet?

But first, how did we get here?

Working from home used to be frowned upon in the corporate world, but lockdowns forced many companies to figure out how to make telecommuting work. Everybody Zoomed. Everybody Facetimed. Employees who could worked in their pajamas from their new home office set ups, often with a child struggling with online school beside them. But you couldn't beat the commute. Many preferred it so much it proved difficult to get them back in the office when lockdowns were lifted. Today many jobs are still fully remote, and they always will be.

And to take things a step further, many workers started wondering why they were paying exorbitant rent on apartments in city centers when they could work anywhere that had reliable wi-fi. For the same cost, why not telecommute from a country home in West Virginia instead? Get some land and maybe even some chickens... Could it be the days of large corporate offices are ending?

But this is just one factor depressing commercial real estate values right now, which is a $20 trillion sector, by the way.

The decline of shopping malls and retail stores has been happening since Amazon Prime started delivering your heart's desires to your doorstep within a day or two. The pandemic spread that concept to groceries and restaurants as well with delivery services like Uber Eats, Instacart and Door Dash so you could "stay home and stay safe". The effect this is having on commercial real estate and the taxes it generates has got to be increasingly alarming to the banks and powers that be. Interesting that just recently, Amazon drew fire from the FTC for its Prime service.

Commercial real estate was also under attack in a very literal sense with BLM riots beginning in 2020 and new relaxed policies on shoplifting in some cities. Rampant crime and urban destruction is hitting businesses hard, and making some exit high risk commercial areas altogether.

What could this do to the economy overall? And are there any implications for your savings? How might this all play out?

Only time will tell, but consider the dominoes that could begin to fall once more commercial real estate spaces are abandoned. Just to touch on a few:

1. * Jobs supporting these buildings go away - think janitorial, restaurants for those coffees and lunches out, transportation services like subways and taxis, etc.
2. * Tax revenue dries up when commercial leases are not renewed. In New York City, commercial property taxes make up about 40% of revenue. A decline in commercial occupancy has already created a 6.5% fiscal hole in NYC's budget. Other cities are experiencing similar budget problems. Will cities be forced to cut services, like policing and sanitation? If they do, will it create a doom spiral by driving even more city dwellers away?
3. * Banks left holding the bag on office and retail space will be vulnerable to further stresses. Small and regional banks hold about 80% of this debt and may not be able to handle the potential coming losses. We could see many more banks collapse under this dead weight, and their assets pushed onto taxpayers.
4. * Pension funds, hedge funds and mutual funds that have deep exposure to commercial real estate could be facing a nightmare of losses and write downs. Think mortgage-backed securities, but commercial. How many portfolio managers bought these up when they looked solid and they desperately needed returns? How much exposure does YOUR portfolio really have, if you dig deep? Many pension funds have more than half of their assets in commercial real estate.

We will be keeping an eye on commercial real estate in the coming months. In the mean time, is your portfolio properly balanced and diversified in case of significant losses across one sector like commercial real estate? Why not consider an allocation of precious metals today?

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