U.S. Commercial Real Estate Facing Potentially Catastrophic Collapse as Values Plummet in COVID’s Wake

The unforeseen reach of the worldwide COVID-19 pandemic has slowly shifted from a health and survival standpoint to a financially calamitous one. The aftereffects of pandemic-caused shifts in societal and workplace day-to-day living have placed enormous pressure on a commercial real estate system already beset by unsustainable growth and inflated value over the past 15 years. And now, in a manner of speaking, the chickens are coming home to roost. 

Years in the Making

Or, to use a term that is perhaps more accurate, the chickens have flown the coop. The percentage of in-office workers is barely half what it was before COVID and emptier offices have led to struggling urban downtown areas and a precipitous drop in inner-city commercial value – in some places 35% or higher. This has led to an estimated across-the-board crash of $76 billion in commercial real estate value. And the market isn’t poised to recover anytime soon. 

Rising interest rates and uneasy worldwide financial footing have left some property owners struggling to meet their bills. ‘Troubled’ commercial real estate assets – defined as properties that undergo forced sales because their owners can’t afford the mortgage – rose 10% during the first quarter of 2023. In the same time span, commercial mortgage delinquencies rose 3%. While rising Federal Reserve interest rates have attempted to stem the tide of inflation, an unfortunate side effect has been to make meeting mortgage payments that much more difficult for owners. 

Ready to Stabilize or About to Slide Even Further?

Market experts are divided as to whether industry safeguards are poised to stem the bleeding or if this is just the beginning of a full-blown market crash. Some analyses have concluded that declining commercial real estate values are an inevitable ‘correction’ for overly optimistic valuations in the 2010s. These bullish insiders believe the current market’s challenges are manageable and point to available ‘anti-default’ tactics that are available for borrowers, the inevitability of interest rates dropping back to normal levels, and that the amount supposedly lost is a drop in the bucket compared to the overall commercial market. 

On the flip side, financial groups like Morgan Stanley are maintaining a less optimistic and decidedly bearish outlook and have begun predicting that this commercial market instability has the potential to become worse than the Financial Crisis of 2008. Rising vacancy rates, plummeting property values, and widespread ambivalence of office workers to give up their remote and/or hybrid work routines may potentially be the catalyst for a ‘perfect storm’ of widespread commercial property devaluation. To make matters worse, the Fed has teased the possibility of raising interest rates even further, in an ongoing effort to spark the stagnant and sluggish national economy. 

Re-Floating the Sinking Ship

To set things back on the right track, some industry insiders warn that nothing short of a paradigm shift in city structure and societal focus might be needed. With a mass exodus of workers from downtown areas to their home offices, many urban downtowns are not adequately equipped to do the one thing that is needed from them – lure workers back with amenities and services. Many downtowns – especially in the Midwest – have been cultivated over the decades as where people worked because, simply, that’s where the jobs were. 

With remote work options now more entrenched by the month now that the height of COVID appears to have come and gone, ‘concrete jungle’ downtowns cluttered with office space and not much else (like entertainment, food, and leisure choices) are in increasing danger of being stuck in a “doom loop” of increasing commercial vacancies, decreasing revenues, and curtailed services, an ouroboros of failing infrastructure that feeds upon itself. Only time will tell if cities have the resolve and foresight to reposition their downtowns as an attractive place for workers to venture out into the office again or if this is just the difficult re-positioning of a shifting society.

Taking Advantage of a Bear Commercial Market

Richards Rodriguez & Skeith’s team of commercial real estate attorneys believe that lessons can be learned from difficult economic times, including the dot-com bubble, the Financial Crisis of 2008, and today’s ongoing ramifications of the COVID pandemic. We’ve been here before and our experience with debt restructuring, foreclosure, litigation, bankruptcy, and a host of other transactional issues have made us well equipped to advise our clients. And one thing that we’ve noticed from braving those storms is that one man’s catastrophe is another’s opportunity, to spin a common phrase. If you’re experiencing commercial real estate challenges or have identified opportunities to derive benefits from conditions in the current market, we may be able to help! Contact us today for more information.