As for nicknames, Columbia Business School professor Steen van Nieuwerburg has one heck of a name: The New York Times called him a “prophet of urban doom” last year for predictions drawn from years of research into the economic impact of remote work on real estate and finances.
He told Fortune that we are now seeing the “event horizon” of a 1970s-style downward spiral known in economics as a “doom loop” — and it's only the first inning.
We all know office buildings across the country have been hit by COVID-19 and the rise of remote work, and perhaps there's no better example than San Francisco, where the number of dusty offices is at an all-time high, nearly 20% of buildings are vacant, capital is bleeding, and the city's tax base is shrinking.
Van Neuerburg and many other economists say the impacts go beyond the real estate industry. Without fundamental reform, he says, New York City could fall into a “vicious cycle” that affects everything from home prices to public service budgets to crime rates. The most famous example was the 1970s, when the “white flight” and fiscal crisis plunged New York into recession for more than a decade.
“Government spending cuts mean less money for transportation, less money for education, less money for sanitation, less money for all the things that make a city attractive,” Van Neuerburgh said in an interview with Fortune magazine.
Van Neuerburg, who joined Columbia in 2018 just a few years after winning the prize for his work on the macroeconomic impact of housing market shocks, sees the “event horizon” of this doom loop approaching soon: As federal subsidies run out and the delayed effects of the tax system play out, he says, New York is in the “first inning” of a potential full-blown urban crisis.
“You're going to really start seeing this in the next three to five years. This cycle is out of control.”
Delayed Effect
Remote work has upended the traditional market for urban office space. Research shows that roughly 30% of paid time off is spent working from home, and the figure tends to be even higher in urban sectors such as technology, media and advertising. Commercial property owners are struggling to break even as demand for office space falls, driving down rents and property values.
The types of offices companies are looking for are also changing. To lure employees back to the office, Fred Cordova, CEO of real estate consultancy Corion Enterprises, told Fortune, companies are looking for newer, smaller offices with more amenities and perks. That's putting pressure on mid-tier (and newly vacant) office buildings that have long been the backbone of the city's commercial real estate sector. The timing couldn't be worse.
“Many of these buildings were purchased after the financial crisis in 2013 and 2014. Most of those loans were 10-year loans, which means there's close to $1 trillion in loans coming due,” Cordova said. “There's no way to refinance them, and most will probably never be able to pay off their debt.”
On top of that, federal funds pumped into the industry to shore up the industry during the pandemic are starting to dry up, threatening to spark a wave of defaults, and because of incrementalism built into the tax code, auditors will soon be feeling the full impact of a wave of defaults that began several years ago, Van Nieuwerburgh said.
That's exactly what city budget watchdogs are worried about. Falling commercial property values are already reducing property owners' tax bills. But if struggling commercial property owners can't repay their debts, and maybe even their taxes, the repercussions could reach far beyond the real estate sector. Just under 10 percent of New York City's tax revenue comes from commercial property, and a significant decline in that source would hit overall budget spending, Van Neuerburg said.
Send out shock waves
The banking sector, which has a high exposure to commercial real estate, is also feeling pressure from the downturn in real estate prices. While the big banks are generally safe, much of New York's commercial real estate debt is held by smaller regional and local banks that may not have the capital to hold up over the long term if vacancies rise and property prices continue to fall. Van Neuwerburgh said banks hold about half of the $6 trillion in commercial real estate debt in the U.S., but of that half, 70% is held by small regional banks.
“Some regional banks that are overly exposed will fail,” Cordova said.
The core of the “doom loop” theory is that it is self-perpetuating. As vacancies rise and property values fall, cities don't receive as much tax revenue, forcing over-lending banks to cut back on lending. That means less public spending on transportation, sanitation, public safety, and less investment in small businesses. A dirtier, more dangerous, and less accessible downtown is less attractive to businesses and remote workers, leading to more vacancy and even lower property values. Wealthy residents may give up and move their families (and their taxes) to lower-tax states like Texas or Florida. And the cycle continues.
“Funding is running out, or has already run out. This is the first year that we're not going to get any additional funding from the federal government. That's starting to hurt…”[And] “Vacancy rates are already at an all-time high,” Van Neuerburg said. “This combination is going to be pretty damaging.”
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