How telecommuting is reshaping commercial real estate (2023)



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18. maj 2023

  • Jonathan Chang
  • meghna chakraborty
How telecommuting is reshaping commercial real estate (1)

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Flooding of commercial properties.

In cities like Los Angeles and Chicago, more than 20% of office space is vacant.

Nationally, unemployment rates are higher than they were at the height of the financial crisis in 2008.

What does this mean for American cities?

Today,In fact: How telecommuting is reshaping commercial real estate.


Dror in addition,an economic historian who examines the development of work, cities and buildings. The authorRethinking Real Estate: A Blueprint for Technology's Impact on the World's Largest Asset Class.

Ted Egan,Chief Economist for the City and County of San Francisco, California.

Also selected

Joe Eskenazi, editor-in-chief of Mission Local.


MEGHNA CHAKRABARTI: For as long as Joe Eskenazi can remember, life in downtown San Francisco has followed a predictable pattern. Hustle and bustle from 9 to 5, and then... nothing.

JOE ESKENAZI: Back in the day before the pandemic, it could be a lot, and then you know, it's almost like, you know, the whistle goes and Fred slides under the dinosaur and goes, Yabba dabba doo, and they all leave the financial. district because it's not a place where people hang out.

CHAKRABARTI: Eskenazi is the managing editor of Mission Local, a news site covering San Francisco's Mission District. He is also a native San Franciscan and has spent much of his life there, including the last 20 years.

ESKENAZI: Nobody says I want to go to the center. I go to a place where there is very little content (LAUGHTER). And there is nowhere to be funny. You know, and it's like a movie that was released after hours and on the weekend. What is different now is that there are fewer people. It's not like trash or newspapers are blowing through the streets. There are just fewer people.

It's not like trash or newspapers are blowing through the streets. There are just fewer people.

Joe Eskenazi

CHAKRABARTI: The bright bell of the San Francisco cable cars is ringing lonely these days. What better way to measure human behavior in a technological city than the activity of people on their mobile phones?

One study managed to do just that. And it found that foot traffic in downtown San Francisco is only 31% of what it was before the pandemic. Yes, a drop of almost 70%. This is reported by the Institute for Governmental Studies at the University of California, Berkeley.

CHAKRABARTI: And Joe says it's not just business offices that have been cleared out during the pandemic.

SKETCH: For all auxiliary finance shops, restaurants and everything else that depends on the turnover of office workers. They are really suffering. You know, it was very difficult to make rent on five meals a week. Because the city center doesn't work, you know, it mostly closes on weekends. And now it is not possible.

CHAKRABARTI: It's the core of downtown San Francisco, he says. The area and surrounding facilities have always been built for commercial real estate... at least since the 1970s.

ESKENAZI: You know, you know, since the Bay Area Rapid Transit came along, which is our intercity train. The whole point of Bay Area Rapid Transit, which spans many roads, like down to San Jose and the leafy suburbs to the east.

The whole point is to bring people to downtown San Francisco to work and then bring them back. Thus, he sets aside an entire district only for office and business premises. In retrospect, you look vulnerable.

Eskenazi says it's unclear whether his downtown will ever return to pre-pandemic levels of foot traffic. But he hopes that if and when that happens, San Francisco will bring back the people who invested in the city's success, not just the giant tech hub we know it as today.

ESKENAZI: In retrospect, giving tax breaks and everything else to big tech companies, which did very well. And if they were looking for a return of loyalty from these companies, they absolutely did not get it.

Because it turns out that having offices for many, many people is a significant expense. Well, you know, in the deep past or not in the deep past, there were, you know, patriarchal types, San Francisco natives, who ran big businesses and bled for the city. Those people no longer exist.

CHAKRABARTI: Joe Eskenazi is editor-in-chief of the San Francisco news site Mission Local.

Elizabeth Weil, another writer from San Francisco, puts it this way:"Before the pandemic, we thought technology was going to save us. ... Now it was clear that technology wasn't going to save us. Technology wasn't even going to stay in the city."

CHAKRABARTHI: That's the point. I am Meghna Chakrabarti. Downtown San Francisco is suffering - office vacancies are close to 30%. But he is not alone either. Commercial properties in major cities across the country are exploding. Office vacancy is close to 13% nationwide. This is more than during the height of the financial crisis in 2008.

And the financial crisis and the real estate crash that followed...the commercial real estate crash may not be limited to commercial real estate. Taxes are the channels that connect office space with the services of your city. And if the companies don't pay rent, it affects the city's bottom line. Let's try to look a little into the future, what might happen if commercial real estate does not recover.

Dror Poleg is with us now. He is an economic historian who studies the evolution of work, cities and buildings. He is the author of the book Rethinking Real Estate: A Roadmap to the Technology's Impact on the World's Largest Asset Class.

DROR POLEG: Hello, Meghna. It's great to be here.

CHAKRABARTI: First of all, tell me, give us a little more detail about the health of commercial real estate in cities across the country. Because an average number like 13% can hide the details of what is happening in different places. So what information do you want to add to this?

POLEG: So in some cities, particularly San Francisco and New York, even Boston, even places like Dallas that people often assume are doing relatively well right now, it's closer to a vacuum. position 20%. When we talk about a vacant position, we are basically talking about a place that is not rented out.

So it is not under contract. But beyond this specific amount, there is also space that is simply empty and still under contract. But this contract cannot be renewed after the expiry. And when we look at it, in many cities the number is closer to 50%.


POLEG: Yes. Compared to the level it was at before COVID. So assuming that even before COVID, of course, not everyone sat at their desk every day, 9 to 5. There was a kind of built-in position. We are currently halfway through many cities. Now, at the peak of COVID, we were close to 100% vacancies or say 15%, 20%. That's how it happened. But in fact it even seems that in recent months it is loosening up a bit.

So it's not clear that it's just going to keep growing, but it looks like it's starting to settle down somewhere. The concern now, looking ahead and not too far ahead, is that as many of these leases come up for renewal, and most of them haven't come up for renewal since COVID, most of them were signed before COVID, so many of them, or a significant part of them will not be restored.

CHAKRABARTI: Okay, just wait a minute. Because I want to thin out a bit. Because you're actually describing a lot of different scenarios here that lead to this, you know, 50% vacancy. First, some of them are simply leases that have expired and not been renewed. Is it 20% you said?


CHAKRABARTHI: Okay. It is therefore income that does not go to the commercial properties that own the office space at all. They lose revenue from it.

POLEG: That's right.

CHAKRABARTHI: Okay. And then there is just an empty piece of office that the companies presumably still pay rent for until the contract expires?

POLEG: Yes. And there is a process. We are now focused on landlords and their building owners. But the employers themselves, some of them still hope that the workers will return and fight it internally, regardless of the rent itself. They're trying to get people back there, trying to hope that they'll come back and figure out exactly what they need for space in the years to come.

CHAKRABARTHI: Okay. Therefore, we will talk about companies. We will also talk about all the jobs that depend on the commercial real estate traffic that the workers brought in. See you in a moment. But I think you said that a lot of those leases, if the workers don't come back to the office, may expire soon and not be renewed. So how far into the future are we looking? Could there be another major turning point in this kind of slow decline in commercial real estate?

POLEG: So these leases are generally more. Industry professionals are not trying to renew all their leases at once, especially with what is going on right now. They assume that the economy fluctuates, that there are surprises.

So you want to be sure that most of your tenants are not even capable of making a decision at any given time. Well, slowly, but it seems that as we move away from COVID, the vacancies are only increasing. Which basically tells us that as more and more leases come up for renewal, vacancies increase.

So right now we don't really see any reason why the leases that come up for renewal in the next year or two just have to be fully renewed. Based on what we've seen over the last year, many companies are reducing their space requirements, either leaving the office entirely or removing it by 20 or 30%, and that's an important point. They move it somewhere else or decorate their offices differently.

Satellite offices open closer to people's homes. So it's not necessarily a story of overall office demand, but a story of the redistribution of that demand and the shift away from buildings that benefited from it until three years ago.

CHAKRABARTI: Buildings and cores in the centers of many cities. Exactly. Alright. So let me ask you again, as I'm not an expert in commercial real estate, are leases typically 10 years?

POLEG: Yes. So ten years would be a good average. It has been declining for the past two decades. So if companies previously signed leases for 15 or 20 years, there are fewer and fewer companies that would do that. But even before COVID, we started to see that the tenants themselves prefer more flexibility, that they are no longer able to project and anticipate their own needs so far in advance.

So if it was previously in the interest of both the company and the owner to secure as much space as possible. And know that they have space. We started to see a bit of a shift in the last ten, 15 years, especially when companies started to show a tendency to sign shorter leases, but landlords insisted on signing longer leases, and landlords had more power.

Even before COVID, we started to see that tenants themselves prefer more flexibility.

Dror Furthermore

CHAKRABARTI: I think you described that in some places we're looking at a 50% vacancy, let's put it that way, for commercial real estate in some cities. How does this compare to the commercial real estate vacancies we saw in the 2008 financial crisis?

POLEG: So he was more moderate. I don't have the exact numbers, but one thing, it didn't happen all of a sudden. Even this crisis was somewhat heated over time by the economic slowdown. Even after the outbreak of the crisis, things got worse.

But they got progressively worse, around 2009, and in some places until 2010. And then, as bad as the crisis was, we knew it was just another crisis like all the others. We did not think that anything significant had changed in the nature of the work itself. But that's the concern we have right now.

CHAKRABARTI: I would like to refer to the historical part of your experience here. Beyond overcoming the pandemic by changing expectations of how many, not all, but many people can't work, how far back do we have to go to see what could be the seeds of this current commercial real estate crisis we're in??

POLEG: So we can go back about 100 or 120 years. One of the most interesting facts about the history of cities, and you know, Manhattan is an example. The population of Manhattan 100 years ago was 600,000 more people than today. So more than half a million people lived in Manhattan 100 years ago today. And what has happened over the hundred years is that the city has changed its orientation from being a place where people live and of course do business, but it's kind of in a very mixed environment.

In a city that is highly office-centric, where offices dominate the skyline, where roads, transport networks and even retail are designed to accommodate this assumption that people come here to work and then commute. We must build services around their schedule and their needs, and all other needs are secondary. And I think we're moving toward a place where there's a rebalancing, where cities have the opportunity to become places to live and enjoy and other things. And to work, but not just to be these kinds of office intermediaries, but to be mixed-use cities.

CHAKRABARTI: In many of the cities that we think of, New York is a good example. There was a period, you know, in the 60s and 70s when the city itself changed. It wasn't necessarily a place where many people wanted to live. But then comes, you know, the 90s and a series of technological explosions. How did it accelerate this concentration of office space that was the core of the cities they built in their center?

POLEG: As you mentioned, people thought cities were over back in the 60s, and then cities became less dense and sprawl increased. You know, a lot of people moved to the suburbs and a lot of jobs in the suburbs. So most of the job growth in the US from e.g. 1960 to 1990 happened in the suburbs, not the inner cities.

But something interesting happened with the advent of the Internet, which was actually expected to destroy cities. You love to destroy offices even more and move people to remote and distributed work. But in reality, as the economy became more dependent on innovation and technology, creativity and services, cities became more important and more jobs returned to cities.

Offices have become larger than ever and work has become more concentrated than it has been for many decades. And in many ways, many urban economists believed that this would be the ultimate effect of the Internet. So if you look at economic theory ten years ago, they almost like to celebrate that they figured it out on the Internet. Like, okay, the cities will actually be fine. They become even more important.

Because creative people will live in cities, because employers will now have access to specialized talent. So they move to those cities and want to hire from the largest possible talent pool that you can only have in a few big superstar cities. Therefore, employment in these cities will continue to grow and offices will become even more concentrated. That was the theory.

CHAKRABARTI: That theory also met the reality that while all this growth was happening, things became very expensive in the same cities. So many of their workers could not actually move to the core of the cities and perhaps moved a lot in and out of the centers.

And it's again workers who can work remotely who don't necessarily want to return to the office. So let me ask you. So you said something earlier that I want to emphasize. Because it is very important here. This doesn't necessarily sound like bad news for high-end commercial real estate, because as urban occupancy declines, we're seeing an increase in suburban office space and demand.

POLEG: I don't know if I would call it growth. Because I don't want it to sound like, okay, you know, the offices are going to be great, but they're just going to be in the suburbs. Offices in the suburbs in general have struggled for a long time, but now in the last year I think for the first time in many, many decades, there are actually more vacancies in the central cities than in the suburbs.

So there is a definite resurgence of suburban offices, or in some cases a resurgence. In some cases, I would say, it relieves the pain. But even here, much of the new demand for offices that will arise is closer to where people live and will not necessarily be met by offices as is currently the case in the suburbs.

Many people want offices that are walkable, that are closer to home, that are close to restaurants, even if they are out of town. But many suburban business parks are notoriously not exactly the most popular or interesting places, especially for people who have moved out of the city and are looking for at least some kind of urban atmosphere. A suburban office is often not the answer to their prayers.

Many people want offices that are walkable, that are closer to their homes, that are close to restaurants, even if they are out of town.

Dror Furthermore

CHAKRABARTHI: You know what I find interesting? I don't know if that's the right analogy or not. But for an individual, if they have enough money to have a financial portfolio, we always advise you to diversify that portfolio if you know something is happening in a particular sector that you are investing in.

Does this advice actually seem appropriate for cities that have begun to concentrate their investment in commercial square footage, as opposed to trying to keep their downtown cores more diverse in terms of the types of businesses coming in? Houses, restaurants, all the things that create the kind of vibrant, sustainable environment you're talking about.

POLEG: Yes, that would be smart. But somehow, even looking at it economically, office buildings seemed like the most conservative, stable, and predictable thing in the world, second only to maybe Treasuries in terms of investment-grade assets. It seemed like it would always be there. You know, it's a building, it's very solid. Its tenants are the world's largest companies.

They signed a lease for ten or 20 years and promised to pay you indefinitely. And as the economy grows and land remains scarce, you'd assume that this thing would, if anything, hold its value as we've seen. And even when people moved out of the city, the offices remained, and in a few decades they became even more important. Therefore, it was very difficult for most to imagine that it would happen.

Also in this country, as you know, about 100 years ago we saw the rise of zoning laws and land use laws, often for, you know, racial reasons and trying to exclude different people and different uses from different parts of cities or suburbs . . And that meant that cities became somewhat ossified, that some plans that somebody made sometimes 100 years ago when they decided, okay, here we're going to have offices. We want houses here. Here we have other things. We are still living the consequences of these plans and it is very difficult for the cities to adapt.

CHAKRABARTHI: Okay. Now let's talk a little more about the ripple effect that the empty offices have far outside the buildings. As well as the effect they have on local economies, on people who may never set foot in those offices. Well, first of all, I want to hear from the Wall Street Journal reporter, Konrad Putzier, because he talked to us a little bit about the impact this is having on the landlords who own this commercial property.

KONRAD PUTZIER: What I've heard a lot from the owner is that it's just a short phase, the pandemic will end soon and then we'll be back to normal. When it became a bit clear that it wasn't going to happen anytime soon, it changed to, well, everyone wants to be six meters away. So, in reality, each tenant now needs a lot more space. Correct?

In fact, this will be great for us as owners. And then you start to see that the companies didn't really care about the six-foot thing. And then eventually, you know, the owners kind of accepted the reality. And part of what I think has made this realization so slow is that a lot of businesses are just locked into these long leases that allow the owners to live in this world of deprivation.

CHAKRABARTI: This is Konrad Putzier from the Wall Street Journal. Answer this.

POLEG: So Konrad describes what I call in my book, The Five Stages of Estate Grief. And that's exactly what we see. So starting with the denial of similar, no, it doesn't happen. They will all be back in two weeks. So little anger. Okay, you have to go back. Maybe we can get the city to force you to come back or try to get the government involved. After some kind of, you know, negotiation. Alright. I might be back in two days. Three days, four days.

Now I think we are entering a stage of depression where we begin to realize that something bad is happening and that something is lost and will never come back. And some people are already in the acceptance phase, and they're starting to think, okay, what do we do now?

How can I change my building to something else? Or how can I change my building to accommodate people who want to work but want something else? And also at the city level, I'm starting to think, okay, if we really accept that some of that office demand isn't coming back, what else can we do to stay attractive and flourish? And there is a lot to do.

CHAKRABARTI: Well, we'll talk about that in a moment, because that's an important kind of approach to the question. But, you know, I imagine a lot of listeners are hearing this and saying, you know, it's going to be hard to shed a tear for billion dollar commercial real estate companies. But let's say there's somebody you know listening in Montana who might never go to a big office building in downtown New York or San Francisco. Is it possible that this person is really investing in the same buildings?

POLEG: Of course. So starting immediately, a lot of pension funds, a lot of pension plans, you know, whether you're a teacher or a freelancer or you work for a large private company, a lot of your retirement money is invested in real money. real estate investment trusts that basically own a lot of office buildings, many apartments and other types of commercial buildings.

And they invest in them because they are almost perfect for a retirement portfolio because they are very stable. The value increases over time, but gradually. You know, they're not Facebook or Snapchat stocks, and they pay regular dividends that come straight from the rent.

So they are perfect for someone who is retiring and just wants to collect a check from their investments every month or every quarter. Again, the pension funds are not entirely dependent on this type of office, but they are a significant investor in this type of building. So we start with that.

There are other industries you could invest in, you know, fast food chains, hospitals, anything around economies that are built, again, it's based on the assumption that there's a lot of people coming in every day from 9 to 5..and you have to eat, they have to clean their clothes, they have to go to the doctor.

They have to do various things that happen around the office schedule. And once you destabilize that schedule, or completely cut off some of that demand, or just move it somewhere else, those businesses suffer. And then we mentioned the fact that all these companies employ people.

So we could be some of those people. And the final influence, or indeed not final, but one of them is the cities themselves. So property taxes are a large part of municipal budgets. In New York, before COVID, it was about 40%, 44%. It actually went down during COVID because there was a lot of outside help from the federal and state governments. So the share of offices and properties has actually decreased, but overall it is around 40%.

And of that 40%, about a third to half comes from office buildings. So when you remove that part of municipal budgets, there is less money for schools, less money for the police, less money for culture and public areas. So many things are getting worse for many people.

And there is also the risk of entering an urban disaster. Basically, things are getting worse. Fewer come to the office, fewer come to town, more businesses close. It is even less attractive to visit. And you know, we've seen it happen before in some of our biggest cities in the 70s and 80s.

CHAKRABARTHI: Okay. So hold tight, because it's almost as we planned. You gave me the perfect way to talk about a city again. In fact, to be perfectly honest, we designed it. But Ted Egan is with us now. He lives in San Francisco and is the Chief Economist for the City and County of San Francisco, California. Ted, welcome to On Point.

TED EGAN: Hi, Meghna. I'm happy.

CHAKRABARTI: Okay, we wanted to get somebody back from San Francisco to give us a reality check on this conversation because we can talk, you know, in terms of data and theory. But I want to know exactly what is happening in your city. First of all, how much do you think downtown San Francisco has changed since 2020?

EGAN: A lot has changed. And I think most of the things you're talking about today reflect what's going on in San Francisco. You know, San Francisco was obviously a major national hub for the tech industry. Technology is the office industry that has taken the most telecommuting and is the slowest to return to the office.

As far as the city is concerned, about 80% of the city's GDP, the value of everything produced in San Francisco, is produced in the office building or office industry. And so, when something as important as telecommuting happens in an office job, it obviously affects every aspect of the San Francisco economy.

About 80% of the city's GDP, the value of what is produced in San Francisco, is produced in the commercial building or office industry.

Ted Egan

CHAKRABARTI: Can you repeat that? Because I'm not sure I heard the right number. How much of a city's GDP comes from things that happen in offices?

EGAN: About 80% among industries such as professional services, financial services, information management. So it's important, I think, for people to keep in mind that these industries haven't left San Francisco. In fact, the tech industry now employs more people in San Francisco than before the pandemic, but they have dramatically changed the way they need office space. And so it had, yes, the ripple effects that you're talking about on downtown businesses, on transportation, potentially on the city budget in the future.

CHAKRABARTHI: Okay. You know, a little while ago I quoted Elizabeth Weil, a writer from San Francisco, who said, "Before the pandemic, we thought technology was going to save us. Now it was clear that technology wasn't going to save us. Technology It wasn't going to save us . It wouldn't even save us from staying in the city." How about that, Ted?

EGAN: Well, I mean, again, it's easy to think that the technicians stayed because they're not in their office buildings. They don't move, but they haven't disappeared either. Some of them moved to the suburbs. And it's true that San Francisco had a significant population decline between 2020 and 2021, the first year of the pandemic. But most of the people who left were not technical workers. They were low-income restaurant, retail and personal service workers who lost their jobs.

And it's actually a team that makes San Francisco feel empty. Some technicians move to the suburbs, but they are still there. Still, I think the reality is that he's saying that we've gotten used to some growth in San Francisco because of the tech boom that was so deep in the 2010s, which drove demand for everything else in the economy and paid big taxes . And these effects were smaller when they were not physically in the office.

CHAKRABARTI: We'll talk more about the impact because of these vacancies. But don't they have an impact on the real value of the buildings themselves? Because I think about all the different ways that banking and financial services are involved in commercial real estate.

POLEG: Yes, they certainly have an influence on the buildings themselves. And those buildings now have a double or triple boost because even though business was great and everything was as it was before, interest rates are now significantly higher than they were before COVID. Which means that if your loan falls due, you have to have a new mortgage on your building, which happens on average every ten years, e.g. for an office building.

Suddenly, even if your income is high, you have to pay two or three times more interest. So this is the problem. Now if your income is suddenly 20% lower because vacancy is 20% lower and rents are probably even lower. So even the space you rent, you earn less. Now… your housing burden sometimes becomes unbearable. And we have already started to see some large financial players start to return their buildings to the bank instead of paying off their loans or taking out new loans.

So companies like Brookfield and PIMCO, big owners of commercial real estate or commercial debt, have pretty much already decided they're just not interested in refinancing their building. They would rather return it to the bank than try to pay. So even if everything is going well and your building is doing well, the lenders themselves are not at all interested in touching the offices. They are trying to avoid this category just as they tried to avoid retail five or ten years ago. So there is a kind of cover fear from dealing with offices. Again, this can turn into a self-fulfilling prophecy, creating a sort of downward spiral.

CHAKRABARTI: You said the company is called PIMCO, you're talking about an investment management company.

POLEG: It is their branch that invests in real estate.

CHAKRABARTHI: Yeah, okay. It's a name that sounds surprising, given that PIMCO has $1.5 trillion in assets under management. And even their subsidiary says, no, we have to take those buildings off our books.

POLEG: That's why it's worrying. I mean, they don't go because they don't think they can pay. They probably have money to pay, but again, each investment is in a separate fund. That's another story. It's not like you can take the money from their technology or healthcare investments and use it to pay off their mortgage.

But they actually make a ... financial decision and say, okay, is this building worth more in my hands, or is it really better to let the bank take it over and take the consequences? I also think that they regularly want to signal to other lenders that they may do business with in the future that they are willing to go the extra mile. Well, sometimes, you know, rent out some buildings so the next bank you renegotiate a loan with knows you're really willing to give them the whole building. And the banks don't want that.

CHAKRABARTY: So could this aspect of the commercial real estate challenge that we're facing now trickle down to the broader economy?

POLEG: Yes, it puts pressure on banks, especially regional banks. Who are the major lenders as most commercial real estate loans are made in regional banks. So some of the banks that have been in the news recently, like First Republic and Silicon Valley Bank, are among the largest lenders in their local offices. This is by design. It's actually not a bad idea. They want the people who are closest to town and country to lend money to local entrepreneurs and landlords.

And the banks, they are not very dependent on these office buildings, but they are somewhat dependent on them. And what happens when they are suddenly squeezed for other reasons, again, partly because of rising interest rates, which means they earn less because their savers now expect to get more interest on their money.

They turn to the safe stuff on their balance sheets, like Treasuries and Treasuries, to actually provide a cushion. But right now, both of those things don't provide that cushion. So they kind of push them. And they actually do more damage to them, basically. And that exacerbates the kind of low-intensity crisis we have right now with regional banks.

CHAKRABARTHI: You feel very gloomy. Ted, let me get back to you because again, I'm asking specifically what's happening on the ground in San Francisco. A little while ago we talked ... about all jobs. And actually you mentioned that as well, Ted, what was created around these tech giants that sent their workers to downtown San Francisco, the companies that came up to help them. You know, food, other services. The workers in those companies were hit hard by all that empty office, Ted?

EGAN: Well, it's hard to say that workers have. I mean, unemployment in San Francisco is less than 3%. You know, it's one of the lowest in the state of California. In recent months, it has risen from 2%. But it's hard to say that this adjustment really affected workers, or at least the effects during the pandemic. And people responded, many of them, by moving out of town. But it really affects small businesses.

Unemployment in San Francisco is less than 3%. ... It is one of the lowest in the state of California.

Ted Egan

You know, the sales that we're seeing near downtown are still down in some cases, you know, a third of what they were in 2019. And that's in stark contrast to what you're seeing in retail trends in other cities. And it is because of office workers, but also because of the lack of business tourism associated with offices. This is another industry that has been hit hard. And it is connected to our office premises. So without tourists, business tourists, delegates, office workers, these businesses in the city center simply have no customers.

CHAKRABRDI: Okay. So come to the bone, Ted. I mean what kind of impact does that have and do you expect it to have on San Francisco's tax revenue.

EGAN: Well, you know, San Francisco is an unusual city in many ways economically. And our property tax, which in many cities is the majority of our revenue in San Francisco, is only about 20% of our revenue. We also have Proposition 13 in California, which essentially limits your property tax revenue in good years, but cuts you moderately in bad years.

So we predict bad years for all the reasons Dror talked about. We tried to predict what rising interest rates and falling income from properties in our office building would mean to the market value of those properties. However, most of these properties are essentially in the evaluation stage. That is, they pay property tax if they were worth less than they are. And this means that they can experience a real loss in value without actually having to pay less tax.

There is a good example of that. Last week we finally had a big office building sale. You know, office buildings don't sell very quickly. And this building, it looks like it's going to sell for maybe 75 to 80% less than it was worth before the pandemic. But since it hasn't been sold since the 90s, it doesn't look like it will pay less tax. It just softens our pillow. This is a California only thing, only in San Francisco. But for our particular fiscal situation, it will help us.

CHAKRABARTHI: Okay. The glory of a windfall, I suppose. But Ted, you also said that 20% of the tax revenue comes from commercial real estate to the city of San Francisco. I mean, correct me if I'm wrong, I can't imagine that because city budgets have been bursting with excess money for several years now. So even a 20% reduction, I mean, isn't that likely to affect the funds available for other city services?

EGAN: I think it will. It's actually 20% on all real estate, and most property taxes are residential. Of this 20%, less than 20% is the office. But you are right. I mean, from a financial planning perspective, not only from our property tax, but we have a significant business tax that is impacted by telecommuting. We need to get into a mindset of slower growth than we've seen in the past.

Whether we will actually see tax losses depends on the size of it. But we're coming out of a period where we had a lot of support from the federal government during COVID-19 that ended. At the moment we are swimming alone and our financial situation is not as strong as it was.

CHAKRABARTHI: Is it a doomsday scenario?

EGAN: I don't think so at this point. I think that we as a city have serious challenges. But I still don't see the momentum driving the industries that drive our economy out of town. I think that's what we should be concerned about if we start seeing tech workers move out of the Bay Area because they can get a bigger house somewhere else. We don't see him yet. I think we should be concerned if we see that the crime situation in the city center is getting worse and that is keeping people away from the city center.

But actual crime, crime keeps getting better. So we have to worry about transit. The recovery of our transport is weak and we need a transport service in the center of the city. There is no improvement in the city center. So this is a challenge. So we have a number of challenges. You know there are some risks of a doom loop situation, but I don't think we're there yet. And I don't think the risks are great. There are only so many of them.

CHAKRABARTHI: Okay. So what ties all these things together? Buildings, transportation, businesses, etc. are people, right? You need people there. And so, you know, when I think about what could be done with all that square footage, I know the listeners are screaming into their radios or their phones right now. Housing, housing, housing and housing, which of course is an incredibly hot topic in San Francisco. So is there any chance that any of these buildings could be converted into housing for people who need it?

There are some risks of a doom loop situation, but I don't think we're there yet.

Ted Egan

EGAN: I mean there's a chance that could happen. Of course. But I think people need to keep in mind that living in San Francisco is also associated with the office. It has been a phenomenon since the beginning of the pandemic that the real estate market is the weakest in the urban cores, and it was the weakest in San Francisco among all other centers.

So if you're a developer and you're looking at an office building, say, hey, I'd like to buy it and turn it into residential. You actually have to cross three obstacles. The first hurdle is that the owner of the commercial building is unlikely to give it, at least until recently commercial building owners have resisted selling at the huge discount you need. Because office buildings were so valuable, especially in San Francisco.

Therefore, getting an office building at the right price is an obstacle. Another obstacle is the price. I mean, there's less reason to live in downtown San Francisco when you don't have to go to that office as often. And businesses that would create a glorious environment that would attract downtown residents are in many cases not open.

So what is the appeal of downtown? As a result, your rates are lower. And finally, construction costs are very high in San Francisco and have not decreased. In fact, they have increased a lot with the inflation we have had. So the economics of that conversion are very, very difficult for reasons that, you know, may not change quickly. I could see some of this happening maybe several years into the future. But I think the first thing that will happen is a reversal in office prices that we haven't seen yet. Our office rents are still, you know, at the level of 2017. They're coming down a little bit. I think they can drop further and then we really have to see what the office tenants want.

CHAKRABARTI: Sir, I have a few questions for you. But first, I'd like to hear some of your ideas for what can be done with the commercial square footage.

POLEG: First, after hearing what's going on in San Francisco, I can be a little optimistic and say that in many other cities things are better right now and in terms of where I can go in New York. I like San Francisco. There are many people who would like to move and live in Midtown Manhattan, even in Brooklyn and Queens, if you let them. And there are plenty of good and fun things to do besides going to work.

And we really feel it on the road. While San Francisco is much emptier than it used to be, Manhattan, Brooklyn and Queens are full of people and very vibrant. Apart from the fact that the offices are empty, the restaurants are full, the parks are full, the streets are full. So if we convert more offices to apartments, it will make a big difference. There are significant hurdles, as Ted pointed out, even just on the engineering front. You know, it's really, really hard to convert most of these office buildings into apartments and actually have regular apartments with windows and bathrooms.

CHAKRABARTI: I would say, yes, the production requirements are different.

POLEG: ... One thing to note, too, is that the kind of macro perspective that Ted just gave us, which is the only right one as far as it goes, can miss all kinds of things that are going on below the surface. So while many workers, for example, are still registered and working in San Francisco, many of them are not actually physically there anymore.

So if you look at the more specific data from companies that deal with employment contracts and option contracts, there's a company called Carta that does that. In the tech industry, I think about 60% of new hires last year were actually in a different position than the company that officially hired them. So if you look at the company's employees, you might think that they are all growing up. ... but in reality there may be undercurrents that send people and use elsewhere that we should monitor.

But overall, I think we're entering a world where cities have the opportunity to be more important and more vibrant than ever before because they can do all the things that we can't do anywhere else. Again, density, walkability, diversity of people, access to culture, even reality. You know, we can't even know what's real on the internet anymore, can we? There are so many deepfakes and that.

If you want to interact meaningfully with people, cities are the last place you can really make that happen. But to realize this potential, cities must be ready for change. They must enable conversions, they must enable easier opening of new businesses. and they should try to make them more affordable so that people who really want to live in them can do so.

I think we are moving into a world where cities have the opportunity to be more important and more vibrant than ever before.

Dror Furthermore

This program was broadcast on May 18, 2023.

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