Discover more from Peter St Onge, Ph.D.
"Urban Doom Loop" Drives Time Bomb in Commercial Real Estate
America's cities, like America's banks, are fast becoming Third-World.
Recently, Bloomberg warned that empty office buildings have become a “Debt time bomb” as commercial real estate threatens to gut regional banks who keep 43% of their bank loans in commercial real estate, with 40% of that in office space.
More important, crashing property is a symptom of the rapid death of America's biggest cities as socialist politicians render their cities unlivable despite record government spending.
Bloomberg kicks off with owners of “gleaming office towers" in San Francisco walking away from their debt while San Fran's largest mall was just abandoned by its landlords, leaving a $558m mortgage. Two of the city’s biggest hotels were defaulted leaving $725m in debt, while a $1b portfolio of apartment buildings was just stiffed.
Bloomberg doesn't want to get into social policy so they stick with the obvious economic driver: cheap debt. In fact, Mises Institute economist Mark Thornton maintains a recession tracker, the Skyscraper Index, that flashes red whenever a "world's tallest building" is born. As in, cheap money overbuilds, and ends in real estate disaster every time.
As the money dries up, commercial real estate prices are now plunging, with "institutional-quality" offices losing 27% in the past year, apartment buildings down 21%, and malls down 18%. San Francisco's office vacancy rate is now at 32.7% — pre-pandemic it was 4%. A recent study from Berkeley found cell-phone traffic is actually down 70% in the city compared to pre-pandemic.
For decades you had to sell your first-born to get a choice office lease in San Francisco. Now those offices are all but abandoned.
Even without the suicidal city governance, going by 2008 it would take years for prices to recover -- one major analyst thinks 10 years. That's 10 years struggling regional banks do not have. In fact, one study from Columbia and NYU says price will never recover, that remote work alone could permanently devalue property in cities like New York and San Francisco by half. This would leave a trillion-dollar hole in regional banks, doubtless for the taxpayer to bail out.
Cities Hollowing Out
While every boom-bust cycle hits real estate hard, what should be a cyclical crisis is being magnified by suicidal governance of some of America's biggest cities to satisfy utopian activists who almost seem to root for the violent criminals and against the fleeing middle class.
To take San Francisco as a bell-weather, last month home-grown Old Navy announced it’s closing its San Francisco flagship store, joining Walgreens, T-Mobile, Whole Foods, Amazon Go, and Nordstroms in exiting the city. The main commercial drag — Market Street — is now festooned with “for sale or lease” signs.
Asked why they were leaving their hometown, one Old Navy manager said shoplifters hit his store “at least 12, 14 times a day. We were hit 22 times in the last two days.” Recently a video made the rounds of one shoplifter in San Francisco using a blowtorch to open locked shelves in a touching end-of-Empire vignette.
In an almost comical response, the California Senate then passed a bill to make it illegal for store employees to confront shoplifters.
At this point stores in California's biggest cities are just waiting until their lease is up, then they’re gone. Which sucks if you’re a chain store, but really sucks if you’re a mom and pop with your life savings at stake.
Now one of California’s largest insurers, State Farm, recently announced it’s exiting the entire state for business and property insurance — insurance giant Allstate already left 6 months ago. State Farm cited the “challenging reinsurance market” — meaning they can’t get anybody to insure their California policies.
This means thousands of Californians are now going without insurance — “going naked” in the lingo. Note this locks you in — you can’t sell your house since most banks won’t write a mortgage on an uninsurable property.
Fortunately, the city of San Francisco is on the job: they just released a glitzy $6m tourism campaign. Literally the next day 2 of the biggest hotels in the city went bust, citing “street conditions.” Almost as if the hoteliers didn’t think the tourism campaign would do anything if tourists are afraid of getting hit in the head with a brick.
“Urban Doom Loop”: When Cities Die
Beyond the tragedy for the victims, some of America's biggest cities are now circling the drain of an "urban doom loop" as fleeing businesses and fleeing middle class drain tax revenue. Plunging taxes drains public services like police or sanitation, driving up violent crime and leaving streets covered in used needles or human feces. To give a sense, in San Francisco, pre-pandemic downtown accounted for 75% of the city’s tax base — almost half of sales tax and 95% of business tax revenue.
So if downtown becomes a ghost town, San Francisco runs out of money — it defunds the police whether it wants to or not. At which point the middle class flees, and they flee faster with gun control typical of large American cities. See Detroit or Baltimore for the rest of that story.
By the way, San Francisco's solution isn’t to make the city livable with its still-robust tax revenue. It’s to use it to convert downtown office buildings to — wait for it — public housing. Over eleven thousand units according to one plan. Which should do wonders for bringing back that downtown tax base.
In fact, one local activist group, Shaping San Francisco wants to skip the humans altogether and literally knock down the skyscrapers — “deconstruction” they call it, since tearing things down is a bit of a fetish on the left. This was indeed done with Detroit, when the government gave up on luring back the middle class and simply knocked down 15,000 houses, many of them Victorian mansions, using federal tax dollars.
The only hope in the sickening decline of America's greatest cities is that the urban voters who keep electing these clowns are the first ones to feel the pain. Some *are* waking up, snapping out of their warm utopias to demand city officials actually arrest violent criminals. But they’re not waking up nearly fast enough going by recent elections in Chicago and New York of socialist accelerationists promising yet more lawlessness, wiped out small businesses, and raiding the dwindling treasury to buy yet more votes.
So what's coming next? Given cities are getting worse, not better, expect more dying cities, more failed businesses, bankrupt hotels and, if they keep going, “deconstructed” cities. All of which magnifies the commercial property crisis already hitting banks from the cheap money cycle.
The most likely end result is gutted regional banks that, like First Republic, are first bailed out by taxpayers then is bought up by Wall Street, leading to further concentration of America's banking system in the hands of crony "too big to fail" bankers.
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