In my experience, there’s always been a boom-and-bust pattern to the market for urban office space, despite its record of longer-term strong profit growth.

The traditional sequence goes something like this:

–the economy expands; companies need more office space as they hire more workers; the central business district gets filled up and rents there rise, sometimes sharply, so companies turn to office space in the suburbs

–at the same time, developers start large new CBD projects, which will only open after several years

–new CBD office space comes on the market–often as the economy is peaking, or even contracting; the combination of lower initial rents needed to fill these new buildings + economic softness = companies leave the suburbs and consolidate workers in the center city again.

Over longer periods, the newest, highest-quality CBD buildings perform the best; older and suburban buildings feel the boom/bust the most.

Confidence in a strong secular growth trend underlying cyclical fluctuations has made urban office buildings the premiere sector for real estate investment in the US and elsewhere.

What’s new:

–remote work is an important feature of post-pandemic life, implying lower overall need for office space. Here again, it seems to me, older, less centrally located space is faring the worst, though–but in a market where contraction is likely more than cyclical

–sponsors of traditional pension plans now routinely own not only stocks and bonds but also have large chunks of their assets in private equity or private real estate investment funds. The latter have, on paper at least, held up better than the public markets. So plan sponsors have begun to rebalance their portfolios–taking money away from the private portfolios to reinvest in public markets. This is a risk control measure, not necessarily expressing a view on the relative prospects from this point on

–private real estate funds have responded by invoking contractual limits on the size of withdrawals and by culling their portfolios of their weakest properties. In some cases, this has meant the funds defaulting on loans secured by buildings they now think will be incapable of servicing their debts, leaving the bank lenders in possession of the properties

–(new to me), but also apparently happening. In the bad old days of bank lending to emerging economies, an international bank consortium would finance, say, a 10-year project likely to generate its first cash in year five, with a four-year loan. That meant that the borrower would not only have to pay large origination fees at the beginning of the loan but would also have to negotiate new terms in mid-loan, since it wouldn’t have cash flow to make interest payments (generating even more bank fees). According to a recent Businessweek article I’ve just read, the same kind of thing is now a feature of the office building market.

This might have been just a bump in the road if we envisioned ever-increasing demand for office space, at higher rents, that would eventually cover the increased costs. But it seems to me that scenario is far less likely today that when the construction loans were taken out.

So commercial real estate–and commercial real estate lending–may be in worse trouble than I’d been thinking.