The Coronavirus and Commercial Real Estate: In the Long Run Neither is the Real Threat to New York

The debt-driven U.S. economy was heading for a crash before the coronavirus even hit.   And in some metro areas, including New York, the excess concentration of economic activity during the past decade had sent the cost of commercial and residential real estate to unaffordable and unsustainable highs.  Moreover, the wealthiest generations in U.S. history are now over age 62, with later-born generations much poorer – and facing large costs from the past as well.  And now a once in a century pandemic has accelerated an economic and social crisis that was always in the cards.  None of this, obviously, is good.

With regard to commercial real estate, however, a market adjustment that some might see as a calamity is actually part of the solution. Lower housing prices would allow later-born generations to pay less for housing, offsetting some of their other disadvantages.  Lower residential rents might cause apartments to go through bankruptcy, foreclosure and workout, eventually causing existing asset holders to take losses on mortgage-backed securities.  But the lower building prices would allow future landlords to charge less and still make money, in turn allowing tenants to live better on their lower incomes.  Lower commercial rents could also cause the value of commercial mortgage-backed securities to fall.  But they would also make it easier to open a business, even if it doesn’t produce a high level of revenue per square foot right off the bat.  A market adjustment on the price and property value side, and private sector creativity, could forestall damage on the occupancy side, allowing buildings – and the communities they are located in — to be re-occupied and maintained, and the economy to re-boot.

And yet there is the possibility that things will turn out much worse for many parts of the country, including New York City.  I would divide the real threats into three categories: federal, state and local.

According to land economics, of the four factors of production – land, labor, capital (including investment in buildings) and entrepreneurship – land is the last to be paid.  The others are mobile, and could move away to places where a better deal is on offer, while land is stuck where it is.  On the other hand when you have an economic boom in a particular place, land owners end up with most of the excess benefit, as soaring site prices squeeze developers, business owners, would-be home buyers and apartment renters alike.

That is exactly what happened during the 2010s in places such as New York City, metro Boston, metro Austin, downtown Chicago, all of coastal California, and a few other places.   Development site prices soared, meaning new buildings were difficult to build profitably despite soaring rents.  Rents soared relative to personal and business incomes, and so did the paper value of existing real estate, not because the buildings suddenly became better, but because the place where they were located became more expensive.  This economic boom left most people little better off than they had been before, and caused some people and firms to be pushed out entirely.   The greatest beneficiaries of the boom were those who owned property before it got started.  Their paper wealth soared.

Now it may fall.  But that’s OK.

There are three parts to the commercial real estate market.  The market for space, between property owners and property users.  The for-sale market for physical real estate, between current property owners and future property owners.  And the market for paper assets backed by real estate, between current and future investors.  Falling values and prices hurt those on one side of the transaction, but help the other, and allow the market to clear.

The federal government threat to New York, however, is that in order to keep the value of paper assets as high as possible, to benefit older and richer holders/sellers and the financial sector, the federal government will allow real estate to be held vacant, to prevent price discovery in the market for space and buildings.

Vacant space would be offered for sale or rent at sky-high prices, and remain empty, but that would keep the cost of the remaining occupied space high for tenants.  Mortgage lenders and servicers would be allowed to “extend and pretend” and keep the purported value of the paper assets high, until someone could be found to overpay for them.  The market would freeze.  Instead of lower rents for tenants and lower prices for those looking to buy, there would be more empty, deteriorating space, and eventual abandonment. Some physical assets would be destroyed to preserve the unaffordable prices of others.

This is not an imagined scenario. This is exactly what happened to individual homes nationwide in the wake of the 2000s housing bubble. Instead of being forced to sell houses at the price the market would bear, financial institutions were allowed to keep them on their books at higher values for years, all while allowing them to deteriorate.  Many became worthless and abandoned.   The resulting housing shortage, however, inflated the median existing home price of the houses that remained to more than it had been even during the 2000s housing bubble – even as the average income of later-born generations – the buyers — fell.   For-sale housing prices and rents increased relative to income, leaving the property and mortgage owners richer, and the vast majority of Americans poorer.  The average share of income spent on housing kept on rising.

But this didn’t happen everywhere.  In Downtown Miami, massive overbuilding of luxury condominiums in a fringe location caused a large number of developers – and their lenders – to go bankrupt.  The buildings were auctioned off, and new owners were able to offer high quality apartments at low rents. Young adults surged in to take advantage, and downtown Miami became something it had not been before – a vibrant, active, hip community.  With the FDIC bailing out the banks, Downtown Miami in effect ended up with a massive federally-subsidized middle income housing program, paid for by the rest of the country, by the back door.

Today, however, there is every reason to fear a repeat of “extend and pretend” – and widespread vacancy and abandonment despite high asking rents — on the commercial space and apartment side.  Even before the coronavirus hit New York City was facing elevated retail vacancy in some locations where buildings had been purchased at high prices, and mortgage loan pro-formas required space to be rented at very high rents. Allowing the spaces to be occupied at market-clearing rates would trigger defaults, so owners continued to keep the space empty.

In the prior post, I mentioned that Bicycle Habitat, a firm that operated a bike shop in Soho for decades, never missing a rent payment, was forced to leave when its landlord demanded quadruple the rent.  That space was vacant – with a high asking rent – for years and years.  I have just confirmed that the landlord’s dreams finally came true, and they got two high-end boutiques catering to the international rich to occupy the spaces.

Digital First ‘Leisurée’ Brand Lively Opens First Retail Store

Anyone want to bet how much of a rent reduction they are now asking for?

Meanwhile, there appears to be a level below which the federal government will not allow stock prices to fall, to the benefit of older and richer asset holders and executives using “shareholder value” to justify their bonuses, and to the detriment to younger retirement savers who would benefit from buying in at lower prices.  How long the government will be able to keep the charade going is uncertain, but the fact that the Federal Reserve was willing to buy the junk bonds of over-leveraged companies to keep their stock prices high implies it will take extraordinary measures to keep asset prices inflated.  And the government has already guaranteed that poorer-on-average future taxpayers will take the losses on multifamily mortgaged-backed securities out of their lower incomes.

Elected officials, acting on behalf of campaign contributors, are pushing to have the policy extended to commercial real estate, so that commercial real estate rents and prices can remain sky-high for anyone who wants to open a business.

Without a long-term relief plan in the face of an elongated crisis, CMBS borrowers could face a historic wave of foreclosures starting this fall, impacting local communities and destroying jobs for Americans across the country.

Actually it’s high rents for empty space that have destroyed, and will destroy, jobs.  As noted by WSJ commenters who criticized the article.

Same as before, this ignores the responsible investor who thought the sale price made no sense and was only justified by the type of aggressive lending that could happen with CMBS. If a CMBS fails, guess what – the property doesn’t go away. A better investor will buy it for a lower price and therefore be able to charge lower rents. Bailing people out does not allow the market to reset and artificially ends up inflating rents and prices.


As noted by others, this is transparently a bail-out for CMBS bondholders. The reality is that banks are working with commercial real estate borrowers in distress. The CMBS market will need to address the defaults and work out concessions to avoid wholesale foreclosures…the CMBS investors need to take the pain of devaluation of their securities. These non-bank lenders have been extending excessive debt for a long time…now investors need to take their medicine.



While the federal government sees later-born generations and businesses without special deals as a cash cow, the State of New York sees New York City – with its many residents who are immigrants, working young adults, and operators of businesses without special deals – as a cash cow.   During past economic cycles the rest of the state has had three attitudes toward the city’s financial needs – “you don’t deserve it,” “you are doing well and don’t need it,” and “sorry but we are doing poorly and we don’t have it.”  We may be about to move from the second to the third.

During the early 1990s, when NYC had a soaring crime rate and 1 million people on welfare, the attitude was that the city didn’t deserve more state money. Even at that time, reports from the Greater Rochester Chamber of Commerce and the New York City Office of Management and Budget found the city paid far more into the State of New York in taxes than it received in state funding.  City residents, however, were blamed for the city’s high poverty rate and low labor force participation.  The additional money the city received for programs such as Medicaid were traded for lower levels of school spending and infrastructure investment.

During the 2000s and 2010s the economy of New York City was relatively strong, while that of the Downstate Suburbs and Upstate New York was relatively weak.  Outside NYC rising local government employment, funded by state aid, was used to provide high-paid jobs with benefits to replace the private sector jobs that were lost, with New York City residents paying state taxes to fund that high-end welfare program.

By the mid-2010s Manhattan alone accounted for more than half of all New York State private sector earnings at work, if the substantially government-funded Health Care and Social Assistance sector is excluded.

In 2016, state and local government workers accounted for 10.4% of total earnings at work in New York City, down from a “big government” peak of 13.4% in 1991 and below the U.S. average of 12.6%.  The comparable figures were state and local government earnings at 17.1% of the total in the Downstate Suburbs, 20.3% in Upstate Urban Counties, and 26.2% in Upstate Rural Counties.  In the latter area, the number of students per public school employee has fallen to just 6.5.  Obviously the residents of these areas don’t have the money to pay for this themselves.  Upstate New York continues to lose private sector income, as the consumer spending created by pensioned retirees from the likes of Kodak and GE dies off with them, and is likely to demand more and more state tax revenue to continue to have the kind of public services it believes it is entitled to.  As more and more money was extracted from NYC residents to pay for it, the state slashed the maintenance of the subway system that carried them to work, to save money, causing it to degrade.

And now NYC has been hit disproportionately by the coronavirus crisis, with lost businesses and residents and lower incomes for those who remain.  And yet it is difficult to imagine, based on the past 60 years of history, the rest of the state redirecting the money extracted from NYC back to the city, and providing net assistance instead.  In fact, city residents have been last in line for the state tax revenues generated in Manhattan, and may be first in line to feel the pain as those revenues fall.  Instead of help at its moment of need, NYC may face disproportionate budget cuts, especially in categories where the damage is cumulative and not immediate, such as infrastructure.


City residents also face a threat from local government, with rising taxes and drastic service cuts to allow politically powerful interests to avoid sharing in any sacrifices.  Over several cycles, each time the city’s economy was up and money was rolling in, unions representing government employees and contractors cut deals with their politicians for enriched benefits, earlier retirements, and reduced workloads.  Those deals are permanent and irrevocable, money that comes off the top long after the politicians whose careers benefitted from cutting them have left the scene.  The money required to service the city’s massive debts also comes off the top.  Most of the city’s special tax breaks and deals are also guaranteed, by state law.

Then when the economy turns down, on the other hand, taxes and fees are ratcheted up and services are ratcheted down due to “circumstances beyond our control.”   Those who took the most in good times give back nothing.  By the time the economy turns up again, ordinary New Yorkers have gotten used to paying more to the City of New York and getting less from it.  So the benefits of there being “plenty of money” once again go, irrevocably, to those working the system.

Over time Downstate New York private sector earnings per worker, including benefit income and excluding the Finance, Insurance and Real Estate sector, stopped going up.  Aside from the “one percent,” in fact, it has probably gone down since the mid-1980s (in Upstate NY it is lower than it had been in 1969).  Meanwhile, the mean earnings (pay and benefits, including pensions), of state and local government workers kept rising by more than inflation.  For a time, rising pay on Wall Street helped to offset this disparity, but that time may be passed.

The earnings per state and local government worker in Downstate NY were nearly 60 percent higher than the earnings per private sector worker, back in 2016.  That disparity has likely grown since.   During the 2010s New York City had the most favorable economy, relative to the U.S. average, since the 1920s.  A more favorable economy than it is likely to have again for another century.  Where did all the tax revenues, and other benefits, from this extraordinary boom go?

And now it is time to make everyone else worse off yet again, “due to circumstances beyond our control.”  Already schools are teaching less, park facilities are closed, swimming is prohibited as lifeguards are cut back, aid to the poor is diminished, and trash collection and street cleaning are less extensive and reliable. It is likely that infrastructure maintenance has also been slashed, quietly.  Where is the list of what has been taken away from New Yorkers, even as the early retirees continue to cash in and move out?  It is nowhere to be found.

And yet the real hit to ordinary New Yorkers is still to come, as money is borrowed, revenues advanced from the future, costs shifted forward, maintenance and reinvestment deferred.  In the hopes that the victims will stick around and keep paying taxes in exchange for less and less, not realizing just how bad things are getting. Just wait until fiscal 2023.  Not until then will it be obvious just how much richer NYC’s public employees and contractors have gotten relative to everyone else yet again, and how much poorer everyone else will be as a result.

In other words, the damage from our diminished circumstances may or may not be mitigated by falling rents and real estate prices, at the expense of financial asset holders.  But the damage from the self-enrichment of New York’s political/union class, combined with the diminished circumstances of everyone else, is certain to be amplified and increased.   Because it is an irrevocable done deal based on what has already happened.

Rather than sharing in any sacrifices, in fact, New York City’s unionized public employees may very well benefit from yet another early retirement incentive to “save money,” to allowing them to head for low-tax Florida sooner.   There was once something known as enlightened self-interest, self interest that incorporates a realization that if you don’t treat others fairly it may come back to bite you in the future.  But with everyone in New York State politics in effect on the same side and safe from any competition, there are no limits, and there is no shame.

That’s where his “negative cycle” kicks in.

According to one critic of New York’s policies, who advocates sparing the wealthy from any sacrifices too, even if it means leaving the poor to suffer and die and wiping out services for the middle class.

As New York’s income base erodes and strains on social programs and infrastructure intensify, he predicted that quality of life will deteriorate, more wealthy residents will leave and tax rates will inevitably increase on those who remain.  In April and May, New York had the largest percentage of residents looking for homes to buy in other metro area.

What would it take to stop the downward spiral?  Even lower real estate prices.

The pandemic has raised important questions about the future of New York City. Will residents flee its concentration of people? Will the need for closely packed elevators cripple city office towers? Can employees work as well from home?

Clues to the answers—or a way to bet on them—can be found daily in the price moves of four real-estate investment trusts that have a majority of their assets in New York and trade on public stock exchanges…

The stocks of New York REITs Empire State Realty Trust Inc.; SL Green Realty which is Manhattan’s largest office landlord; Vornado Realty Trust; and Paramount Group. PGRE all took hits of more than 54% during the one-month bear market in the spring, compared with the broader market’s drop of 35%.  But unlike the broader market, which has regained three-fourths of its bear-market losses, none of the REITs have recovered one-fourth of theirs, and Empire State has recently traded near its lows.

Other places, in the suburbs and Sunbelt, might have a different local government problem.  Land use regulations that prevent property from being reused in a way that it is still useful.  Regulations that prevent commercial properties from being re-used for housing, older large homes from being renovated into small multifamily properties, buildings formerly occupied by high-end stores from being reoccupied by more modest service establishments, etc..  New York City has the kind of rules too, but in exchange for “consideration,” generally does not enforce them.

In the long run the problem is not, in fact, the pandemic.  It is not the commercial real estate market, to the extent that market is allowed to function.  The problem is federal, state and local.


A computer repair business owner see it all.  This video shows it.

1 thought on “The Coronavirus and Commercial Real Estate: In the Long Run Neither is the Real Threat to New York

  1. larrylittlefield Post author

    Here it comes.

    “It’s amazing that we have gone from the great financial crisis to now and still have no better transparency into the banks at a granular level as we do with CMBS,” says K.C. Conway, director of research and corporate engagement at the University of Alabama’s Alabama Center for Real Estate (ACRE) and chief economist for the CCIM Institute. Some banks are more transparent than others and there is definitely a lag in the data, he says.”

    “In addition, the FDIC is allowing banks to forbear on loans and not have to report them as troubled loans for up to 180 days. “We’re not going to see anything big show up in the numbers until this deferral period expires,” says Johannes Moller, director in North American banks, at Fitch Ratings. The next big question is how the Federal Reserve is going to act and whether there will be further forbearance, which will help to determine when clarity on defaults on loans held by banks will be revealed, he says. (According to the Mortgage Bankers Association, commercial banks currently holding 39 percent of the $3.7 trillion in commercial/multifamily outstanding mortgage debt outstanding in the U.S.)”

    Eliminate price discovery, allow the losses to be shifted to others.

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