In San Francisco, a 20-story office building that sold 10 years ago for $146 million was listed for sale in December for just $80 million.
In Chicago, a 200,000-square-foot office building in the city's Claiborne Corridor that sold for nearly $90 million in 2004 was purchased last month for $20 million, a 78 percent reduction in price.
And in Washington, a 12-story building with a mix of office and retail space three blocks from the White House sold for $100 million in 2018 but recently sold for just $36 million.
Such deep discounts have become the norm for office space across the U.S. as hybrid and remote work becomes more prevalent during the pandemic, hollowing out city centers that were once bustling with workers. But commercial real estate investors aren't the only ones losing out. Cities that rely on taxes tied to valuable commercial real estate are also starting to feel the brunt as they face budget shortfalls and consider cuts in response to tax cuts caused by falling property assessments.
“These are being sold at a huge discount,” San Francisco Board of Supervisors Chairman Aaron Peskin said of the city's office buildings. “People who bought at the top of the market are going to take a big loss.”
Peskin said San Francisco's $14 billion budget could face a $1 billion shortfall over the next few years, due in part to declining commercial property tax revenues.
“In the short term, it means less revenue for the city and less vitality for our downtown,” he said.
Since the pandemic, cities across the country have benefited from an economic recovery and an infusion of billions of dollars in federal relief money paid out through the American Rescue Plan of 2021, which has flushed local governments with cash to give pay raises to city employees, renovate local basketball and tennis courts and upgrade sewer systems.
But now budgets are starting to tighten.
A financial report released last year by the National League of Cities said that local government treasurers' optimism is beginning to wane as sluggish sales and concerns about lower property taxes combine with the expiration of federal funding.
The cuts could set off what Arpit Gupta, a professor at New York University's Stern School of Business, calls an “urban catastrophe loop” across the country.
In a research paper updated late last year, Gupta and his colleagues estimated that the national office market lost $664.1 billion in value between 2019 and 2022. To fill the budget holes created by the decline in tax revenue, they assumed, cities could cut services or raise other types of taxes, but that could have downsides, such as encouraging an exodus of businesses and residents, further eroding the tax base and exacerbating the problem.
Gupta likened the situation to the challenges faced by Rust Belt cities in the 1960s and 1970s as manufacturing shuttered and local governments struggled to balance their budgets.
“Some cities have tried to raise taxes and cut public services and found that doing so accelerated people's exodus from the city,” he says. “And it got worse.”
The stress weighing on the commercial real estate sector since the pandemic accelerated remote work trends is clear, and the situation is compounded by high interest rates that are increasing refinancing costs and stress in the banking sector, which holds roughly $3 trillion in commercial real estate debt.
The situation is reminiscent of the turmoil the commercial real estate sector experienced during the 2008 financial crisis when credit dried up. But this time, changes in how and where people work suggest a more profound structural shift in the market may be underway, at least until interest rates fall.
Glenn Seidlitz, president and founder of Washington-based commercial real estate consulting firm Six23, said many building owners and investors are trying to restructure loans and, in some cases, looking for new capital, but for the most part, falling occupancy rates and rising borrowing costs have left the sector in decline.
“Lenders seem to really recognize the underlying problem, which is that if interest rates stay high, there's less money to buy property, and fewer buyers are buying property, and naturally prices will reflect lower demand,” Seidlitz said. “So this vicious cycle will continue until it stabilizes.”
Last month, New York Community Bank Inc. posted unexpected losses on real estate loans tied to office buildings and apartments, sparking worries about commercial real estate and sending stocks plummeting. At a congressional hearing in February, Treasury Secretary Janet L. Yellen acknowledged that the sector could pose financial risks and said regulators were watching for signs of trouble.
A municipality’s risk depends on the extent to which its tax base depends on revenue from commercial real estate.
A Moody's Investors Service report from October said Atlanta and Boston have the credit ratings most vulnerable to fluctuations in commercial real estate prices, but turmoil in the sector will pose a threat to big cities for years to come.
“The rise of working away from the office, combined with an existing trend towards more online purchasing, has led to a significant outflow of spending from downtown business districts,” Moody's analysts said in the report.
Assessment declines tend to be a “lagging indicator” as rents fall on new leases and owners challenge tax assessments when other buildings sell for less, said Thomas Brosi, a research associate at the Urban Institute's Tax Policy Center. He suggested that cities will have to make tough choices about cutting spending and raising taxes within the next three years.
“It's going to start to hurt,” he said.
Major cities are already preparing for the worst.
San Francisco has been facing a surge in tax assessment challenges on commercial buildings, forcing the city to defer maintenance on city facilities to save money. Peskin, who is considering running for mayor of San Francisco, said he has pushed for policies to encourage the conversion of vacant office space downtown into apartments.
New York City's comptroller last summer laid out a “doomsday” scenario in which the city's office building values would settle at 40% below their pre-pandemic peak, implying a budget shortfall of about $322 million in 2025 and $1.1 billion in 2027.
The fiscal situation is also dire in Washington, where office vacancy rates will exceed 20% as of the end of 2023. While signs advertising leases hang in some of the nation's capital's top office buildings, downtown retail space remains empty.
The owners of the Washington Wizards and Washington Capitals are seeking to vacate the city's Capital One Arena and move the teams to Virginia, potentially dealing a further blow to a downtown already suffering from restaurant and retail closures. The Downtown DC Business Improvement District business group estimates the arena generates $341 million in annual spending.
City Chief Financial Officer Glenn Lee projected last year that Washington would face a $464 million budget shortfall between 2024 and 2026, attributing much of the gap to a decline in commercial property tax revenue. In an update last month, Lee warned that conditions in the real estate industry have worsened more than expected and that shifts in demand for office space could have a lasting impact on Washington.
“As more people work from home, the District's transportation and office real estate sectors will likely experience significant changes,” Lee said in a letter to the mayor and City Council speaker about the city's finances. “Fewer people commuting could lead to less demand for public transportation and office space, which could lead to lower real estate prices.”
“Overall, the pandemic and the shift to remote work will likely have widespread economic impacts on the district,” he added.