You've probably seen the recent news headlines: Commercial real estate is the “bomb” that will explode and destroy cities, banks, or both.
But news headlines and many investors and regulators are assessing commercial real estate risk entirely wrong. They talk about the entire sector as if it consists of empty office buildings in downtown corridors emptied out by the post-COVID-19 remote-work economy.
The reality is that commercial real estate encompasses a wide variety of products and locations that combine to form hyper-local submarkets. Many of these submarkets, especially neighborhood retail and mixed-use developments, are emerging from the pandemic disruptions stronger than ever. Investors and lenders who lump all commercial real estate together are missing out on a true market opportunity.
While it is true that the market for office space has experienced significant turmoil, demand for modern office space remains. Vacancy rates vary widely between submarkets and regions, and office-based economic sectors are showing secular growth. Even among distressed office assets, the majority of vacant buildings are still yield-positive or have potential for mixed-use conversion.
Regulators will influence whether office commercial real estate collapses. Currently, regulators are not allowing banks to be flexible in providing loans to commercial real estate borrowers, fearing a repeat of the Silicon Valley Bank collapse last year. This makes sense if there is no medium-term path for the office sector to recover in large part. But flexibility in loan repayment schedules would allow many owners to wait out higher interest rates or reposition their assets to transform or modernize.
Giving borrowers breathing room in the short term is a more attractive option than forcing banks and local governments into fiscal crisis through rigidity or fear.
Outside of offices, commercial real estate headlines overlook the diverse landscape of modest, resilient local retail assets that have demonstrated their durability by surviving the rise of e-commerce. Many are benefiting from new telecommuters who are more likely to shop, dine and play locally. Think about the service-oriented businesses we all still need and use: local restaurants and coffee shops, grocery stores, barber shops, mechanics, dentists and veterinarians. These are all good bets for commercial real estate investors.
One could even argue that the real risk in this subclass of commercial real estate investment is not investors overinvesting, but underinvesting. Millions of entrepreneurs and veteran business owners are already making competitive returns in local markets that could increase if they had the capital to expand their operations, either by directly acquiring and improving additional commercial real estate, or by using land and buildings as collateral to raise working capital.
By abandoning the “precious thing” of office buildings in exchange for the “precious thing” of so-called neighborhood retail, investors are missing out on a profitable opportunity and unintentionally discriminating against Black and Brown communities who will be disproportionately affected by the flight of already scarce capital.
For example, the Federal Reserve’s 2021 Small Business Commercial Real Estate Study found that Black-owned businesses are half as likely as white-owned businesses to get all the financing they want, even for companies with good commercial real estate scores (24% vs. 48%).
On the housing side, even after accounting for commercial real estate and equity risk, minority neighborhoods were disproportionately more likely to receive subprime mortgages in the years leading up to the foreclosure crisis of 2008. With the full hindsight of the housing collapse, it's clear that patient, flexible capital would have allowed many homeowners to preserve their home equity; entire neighborhoods would not have been wiped out, and black, Latino, and Hispanic wealth would not have been washed away to sea for a generation.
When considering commercial real estate austerity policies, investors who care about racial equity should keep in mind that supporting local ownership of local community assets (businesses, mixed-use developments, retail) is critical to narrowing the racial wealth gap. Economic downturns are an opportunity to invest in underinvested Black communities and narrow the gap, especially in ways that increase their ownership.
Regulators have recognized that owner-occupied commercial real estate is lower risk and a distinct subcategory of commercial real estate. Innovative new models that enhance local ownership, such as full ownership by former tenants, shares in limited partnerships, and direct participation in general partnerships, are mature and poised to expand.
And the best part is, as examples like Portland's Community Investment Trust, Chicago TREND, LocalCode Kansas City, and Partners in Equity show, co-investing with local shareholders gives you community support rather than NIMBYism and a shared stake in your investment growing and prospering.
Regulators should be careful not to damage the economy in the name of protecting it. Unleashing the commercial real estate “bomb” would harm elites, institutional investors, owners, and ordinary people in a region already traumatized by the pandemic and decades of disinvestment.
Let’s turn that around by investing in commercial real estate in overlooked and undervalued markets and de-risking those investments by turning community stakeholders into shareholders.
Tracy Hadden Lo is a Brookings Metro Fellow. Ida Rademacher is Vice President at the Aspen Institute and Co-Executive Director of the Aspen Financial Security Program.