What a $1 deal says about the US office market | Top Vip News

Jimmy Yavrodi, a New York City deli owner, looks out somberly from the store he opened 27 years ago in one of the city’s main shopping districts.

“Everything is empty,” he says. “I don’t understand.”

From his position on Park Avenue South, the 61-year-old sent two children to college and employed 12 people, serving sandwiches and salads to office workers who came in from nearby buildings.

Today it offers a window from which to view what some call the “apocalypse” of the American office.

The famous triangular Flatiron building nearby has been vacant since 2019. Last fall, the owners said they would convert it into condos.

Around the corner, a new office across from Madison Square Park is in the works. But its anchor tenant, IBM, is consolidating from other spaces in the city.

Its next-door neighbor, 360 Park Avenue South, has been vacant since 2021 for renovation. The 20-storey building, which sold for $300m (£233m) that year, recently hit the headlines after one of the owners handed over his 29% stake to one of his partners, moving away from the commitments to fund $45 million more in improvements. in exchange for $1.

The area still has Michelin-starred restaurants and stable tenants, including part of the state’s judicial system.

On the street, neighbors will tell you that life has returned since Covid.

But sales at Yavrodi’s Taza Cafe & Deli, which have plunged 70% since 2020, tell a different story: one that reveals the enormous challenges facing office owners across the country and the risks those problems are creating. for the economy in general.

“We depend on office workers and office workers are not here. It’s very simple math,” he says. “If they don’t come to work, places like us won’t be able to survive.”

Four years after the pandemic triggered a revolution in work-from-home practices, especially pronounced in the United States, the change is proving difficult to reverse, and the consequences can no longer be ignored.

About 20% of U.S. office space was unrented at the end of last year, the highest vacancy rate in more than 40 years. according to Moody’s Analytics.

With that number expected to rise over the next 12 to 18 months, the drop in demand is changing the city’s neighborhoods and affecting property values, which have already plummeted about 25% on average across the country. country.

One recent article It estimated that the United States saw more than $660 billion in value disappear between the end of 2019 and the end of 2022.

The declines have coincided with a sharp rise in borrowing costs, creating incentives for even well-financed companies to abandon their properties as the value of their buildings falls below what they owe on their loans.

With about 44% of office mortgages in the country in that position, the problems have raised widespread concerns about how banks – and the broader economy – will absorb the impact as loans begin to deteriorate.

Lenders in countries as far away as Germany and Japan are saving hundreds of millions of dollars in anticipation of loans failing.

The problems are especially acute among local and regional businesses, some of which, like New York Community Bank, have already seen their stocks fall dangerously as investors flee potential trouble.

As banks collapse or reduce lending, analysts say the situation could worsen, making it harder for people and other businesses to get loans and leading to a more severe economic slowdown.

This week in Washington, politicians pressed the head of the US central bank on what officials were doing to avoid the worst.

“There will be losses,” Federal Reserve Chairman Jerome Powell told Congress, adding that the regulator was in contact with companies to shore up their financial cushion. “I think it’s a manageable problem. If that changes, I’ll say so.”

So far, many of the defaults have been strategic, reflecting changes in investment priorities rather than financial difficulties, says Thomas LaSalvia, head of commercial real estate economics at Moody’s Analytics.

He is among those predicting regional pain, not global economic cataclysm.

But the coming months, when many of the mortgages that were taken out before the U.S. central bank raised interest rates will need to be refinanced, will be a test.

“That’s the last part of this story that’s going to play out over the next six to nine months: when and how much heartbreak we’re actually going to have,” LaSalvia says.

“The office market… is going to have to resize and it’s not over yet.”

If interest rates are lowered later this year, as many anticipate, the risks to the banking sector will be “much smaller in scale,” says Erica Jiang, a professor at the University of Southern California who co-authored the paper on bank failures. .

But even without an economic disaster, American cities, which often rely heavily on office property taxes, are feeling the pinch as falling values ​​and reduced activity threaten revenues. on which they depend to finance libraries, parks and other basic services.

In New York, which relies on office properties to generate about 10% of its tax revenue, the comptroller warned last summer that the city could face a deficit of more than $1 billion in the coming years in an apocalyptic scenario. .

He said that represented less than 2% of tax revenue and the city could probably adapt to that challenge.

But the situation seems more serious elsewhere.

In San Francisco, where the shift to remote work has been most extreme, the mayor halted hiring and ordered officials to prepare to cut spending by 10%.

Analysts in Boston, where more than a third of tax revenue comes from commercial property taxes, are predicting looming budget shortfalls and pushing the city to find new ways to raise money.

Warnings have also emerged in Atlanta, Dallas and other cities.

Moody’s LaSalvia says the pandemic accelerated a shift that had been underway for decades away from the downtown 9-5 business districts toward more mixed-use areas.

Although vacancies may cause problems in the coming years, he says supply will shrink and drops in value will also create opportunities for new businesses to come in and reinvent neighborhoods.

“This is a time of shifting centers of gravity, shifting centers of power within each of our cities,” he says.

The Yavrodi neighborhood, where many businesses are investing money in improvements, is arguably among the best positioned to weather the transition.

Across the street, small health care businesses have nearly filled a building that was recently remodeled with the help of city tax breaks.

Next door, at 360 Park Avenue South, a restaurant and business have committed to leasing space, and owner Boston Properties has said it expects the building to be nearly full again by the end of next year.

The tech companies that once drove demand in the area have pulled out, but Peter Turchin, vice president of real estate firm CBRE and the building’s leasing agent, says he’s still seeing interest from financial and legal firms, which have called staff to the office and are willing to pay for top-notch space.

“I don’t think it has any broader meaning,” he says of the $1 deal. “We’re pretty busy.”

The company that sold its stake, which invests funds for the Canadian pension plan, declined to comment.

Yavrodi remains skeptical.

Even if space is rented, it is estimated that only 12% of Manhattan office workers show up in person five days a week.

He says that’s simply not enough to sustain retail businesses like his, especially since many companies are using free or heavily subsidized food to try to make back-to-the-office orders easier to swallow.

After reducing his workforce from 12 to five, changing his menu and expanding deliveries, he sees little anyone can do to address the problem.

“Everyone has different ideas, but they try to put a bandage on a big cut when they need strong points,” he says.

“The way of life in offices, as it was before the pandemic, will never return.”