I recently attended a fascinating real estate investors’ conference for hedge funds, lenders and owners held by the Real Estate Limited Partner Institute. The talk of the conference was the almost complete inability of landlords (other than owners of tier 1 properties) to get any financing at all, except at exorbitant rates around 15% which is more than double the current financing that these buildings have in place.
This underscores what may be the greatest threat to the otherwise resilient American economy. We know that major banks and technology firms have recently been mandating return to the office for three days or more. We now have the first meaningful post-Labor Day employee attendance from Kastle Systems which show national and New York attendance rates at barely above 50% as of the week ended September 13 (NYC was up 7.5% to 50.1%, which beats the alternative). As expected, this was an increase over the summer which was dismal, but unless the situation improves further defaults will increase, and the treacherous triangle of (1) banks with increasing default rates on office loans, (2) building owners with failing properties and (3) cities with declining tax revenues will put the entire system at risk as well as the potential for a soft landing which is hopefully within reach.
Accordingly, when Jamie Dimon demands that J.P. Morgan Chase employees return to work because he believes that is important for productivity, he is also acting out of a legitimate self-interest. This is a situation that bears watching as employers have gotten a lot of pushback. In the past, we have expressed optimism after Labor Day when more employees come back to the office after summer vacation, but we shall see this year. My anecdotal observation is that there seem to be more people in midtown Manhattan, but downtown is still struggling. More creative approaches are needed beyond free lunch, and I believe that short-term tax credits for employers and employees as well as reduced or free transit fares are worth a try to induce employees back to the office.
At the same time, some of the research that contended that productivity was better with work from home is being retracted. For example, in a recent working paper, Nicholas Bloom of Stanford the leading researcher of work from home and two other academics found that fully remote work is associated with 10% lower productivity than fully in–person work. Further, the paper highlighted challenges with communicating remotely, barriers to mentoring, building, culture and issues with self-motivation as factors in their calculus.
This sort of revisionist analysis logically makes me very skeptical of these statistics which initially claimed that work from home leads to higher productivity. As my brilliant friend Michael Hobbs of Intelligent Prospects Ltd. points out, who is maintaining and contributing to these statistics and what is their bias? Unsurprisingly, employees think remote work is more productive than management (which does not take saved commuting time into account, while employees do). Anyone with common sense knows that it is less efficient to have people out of the office, while at the same time if companies take less office space real estate costs will be less. This is what needs to be balanced. As with many things in life, it depends on whose ox is being gored.
So the battle for the office continues apace. For the most part, management has gotten fed up with chasing down employees who are unavailable and understandably most rank and file employees want to keep the flexibility of remote work which has held steady at around 28% for many months as measured by surveys by WFH Research.
According to Trepp CMBS Research, the special servicing rate for office properties rose another 39 points to 7.72% in August 2023. That is 456 basis points higher than the special servicing rate for office in August 2022, which indicates the creeping danger as loans expire and buildings need to refinance.
This metric effectively conveys the fact that as each month passes, the stakes in this vital saga of urban life increase incrementally. Conversions of small numbers of office buildings from office to residential use are welcome, but won’t come anywhere near to solving this major systemic problem. It’s not hyperbole to state that the health of our cities and banking system depends on it.
