Will Financial Issues In Commercial Real Estate Impact Affordable Housing?

In my ongoing series of interviews and exchanges with economists and entrepreneurs, I thought I’d look into commercial real estate and its possible impact on housing and especially on people who earn less money in the economy. In a post at the end of last year, I highlighted the importance of small business for housing. Much has been bouncing around the internet and media about the coming collapse of the commercial real estate market. “Commercial real estate is melting down fast,” Tesla
TSLA
CEO Elon Musk said in a recent tweet. “Home values next.” Is that true? Nobody can predict the future but I asked Takahide Kiuchi, Executive Economist, Nomura Research Institute for his thoughts. Here’s his bio:

“Takahide Kiuchi has been with Nomura for over 20 years and is now the executive economist. He was also a Member of the Policy Board of the Bank of Japan and was involved in all decision-making over Bank policies and operations. Nomura Research Institute (NRI) is a leading global consulting firm that provides solutions and expertise in the fields of IT, financial services, and management consulting.”

As in previous posts, my comments will be in italics at the end of the comments from the economist or expert.

• Would you attribute the increase in vacancies in CRE to Covid? Are there any innovations in response to this that look promising? Could the office share economy benefit (e.g., We Work)?

According to CBRE, the global office vacancy rate was at 12.9% at the end of March, which was almost the same level as the peak in 2009 and 2010 after the global financial crisis. The fact that the vacancy rate has risen to this level while the economic situation is better than it was at the time seems to show that it was largely influenced by the spread of working from home after the pandemic.

However, it is also likely to be a reaction to the excessive expansion of corporate debt, office construction, and office demand under the ultra-low interest rate environment after the global financial crisis. The effects of tightening monetary policy will hit the commercial real estate market hard, which could lead to major financial problems. The shared office business has benefited from increased demand for satellite offices during the pandemic. In the future, if the economic situation worsens and companies become more inclined to reduce office costs, the shared office business will receive even greater benefits.

This sounds like a classic tale of fundamentals. Easy money fueled more production of office space and tightening of that money combined with changes in behavior caused by Covid are causing plunging demand, oversupply, and an inability to service debt incurred to create the supply several years ago.

A few things that are notable here. First, for housing, as noted last month, unit sizes are creeping back up and people are still avoiding smaller urban housing. The rise in office vacancies might end up tracking with this; higher office vacancies might be a measure of just how many people are just working from home. That means the trend downward in unit size might be halted, changing the kinds of apartments people want. Maybe it all offsets, that is, rents might rise but those might be canceled out by fewer commute miles.

I’ve always been a fan of We Work and its model, selling memberships to flexible office space rather than contracts for square feet. It never was a tech company, and I think it was sheer envy that caused people to long for its demise. It’s still here, although still in trouble. But as Kiuchi points out, the flexible model they offer is far easier to manage for companies and people than a 12-month lease for an office. I think We Work will likely have the last laugh if it hangs in there.

• What is the broad effect of CRE issues on housing, especially housing affordable for people earning half of local Area Median Income?

In the US, I think the commercial real estate market and the residential market are fragmented. During the global financial crisis, the housing market correction undermined the balance sheets of over-indebted individuals, and personal economic activity deteriorated. But since then, individuals have held back debt considerably. The ratio of household debt to nominal GDP peaked at 0.99 in the January-March quarter of 2008 and has fallen to 0.73 in the January-December quarter of 2022, down to the level of 2001. Even though housing prices have fallen, there have been no personal debt problems or a deterioration in consumer spending. However, if the correction in the commercial real estate market causes a serious non-performing loan problem for banks, it is possible that banks’ credit crunch will constrain individual economic activities.

Overall, Kiuchi’s assessment sounds positive for consumers; they have less debt in an uncertain economy. What’s interesting is that the collapse of the housing market hasn’t seemed to happen. That is rising interest rates and a slowing economy should have ground lending for housing to a halt. This, along with people camping out in houses with low-rate fixed mortgages wouldn’t move. I also figured we’d see a slowdown in construction and other sectors of the economy that would cause job losses that would mean a 2008-2009 like bust as people couldn’t pay their mortgages.

This hasn’t happened. In fact, one analyst pointed out “housing starts rising from an annual rate of 1.34 million in April to 1.63 million in May. That 27.1 percent jump stands at odds with many of the recent readings of the housing market, but may reflect the paucity of inventory.” People haven’t lost their jobs, and they’re still buying houses, so people are building. I was wrong, at least on timing. What happens when the supposed implosion of commercial office debt happens? We’ll have to wait and see.

• Is there going to be a divide that grows between people who can work from home and those who can’t? And many downtown workers provide demand for retail and service labor supply in downtowns. What happens next?

People who have moved from big cities to the suburbs due to the pandemic and have been working from home are more likely to continue living in the suburbs rather than returning to the big city. High-skilled workers who prefer to continue working from home tend to accept lower salaries. On the other hand, wages for essential workers who cannot work from home and work in metropolitan areas have increased, narrowing the income gap between the two. By moving people to the suburbs and consuming them there, economic activity in the suburbs will be activated. Demand for new laborers will also increase. In particular, people who work at companies that are unwilling to work from home are likely to find a new job in the suburbs in the future.

This is a very interesting observation by Kiuchi. So much of the falderal about affordable housing is that “people can’t afford to live where they work.” I have always doubted this. First, because often people make different choices, living places that are further away not just because the rent or housing is cheaper, but because they prefer the schools or want a house, not an apartment. People don’t make choices based on their gross incomes, but on what they think they can manage to pay for given the benefits they get,

What’s happened is that businesses in urban areas have had to raise wages; workers are scarce. So, people with lower incomes that might have commuted in and don’t have the luxury of working from home – janitors, restaurant workers, retail workers – are commanding higher wages. They have more choices, including working closer to home. The dislocation of the pandemic will likely take years to fully understand, but the shuffling of the deck has likely empowered lower wage workers not only with more money, but better housing choices as well. Those workers might finally be seeing the option of shorter commutes either living closer to work, or working closer to home.