John has written a lot about the "urban doom loop" in which declines in quality of life create declines in property values which in turn leads to declines in public services which leads to...declines in quality of life. 

Rinse, repeat. The doom loop is mainly driven by terrible public policy decisions such as defunding the police and tolerating homelessness and drug use, but the change in how real estate was used during the pandemic contributed a fair amount as well. 

Luxury San Francisco high-rise next to 'X' HQ could default on mortgage

When NEMA opened 10 years ago, it was meant to revitalize the Mid-Market area.

The area has dealt with property crime, homeless encampments and open-air drug markets. @KPIXtv https://t.co/Ah0rQrxXzr pic.twitter.com/1HmLR8E8M2

— Betty Yu (@bett_yu) August 23, 2023

In other words, 2020 was a tipping point for poorly run cities. Add the pandemic shutdowns on top of crappy government and you get disaster. 

😬Worth a read 👇

The Brutal Reality of Plunging Office Values Is Here ... BBG

Commercial-property deals in the US are starting to pick up — at deep discounts that are forcing lenders around the world to brace for souring loans.https://t.co/anh6yLcs7w

— Trading Floor Audio (@TradeFloorAudio) February 15, 2024

Disaster is a mild word for what might be happening in today's commercial real estate market. Prices are plunging, which sounds good at first, but don't forget that most of these buildings are financed and not owned outright. When a building that is financed is worth half of what is claimed on the books, it isn't just real estate investors and property taxes that take a haircut--it is the people who own the debt as well. 

Before you shrug and say "boo hoo," this could be a disaster for you too. Remember the 2008 financial crisis? It, too, was driven by froth in the real estate market, although then it was mostly home mortgages. 

Across the country, deals are starting to pick up, revealing just how far real estate prices have fallen. That’s spurring widespread concern about losses that can ripple across the global financial system – as underscored by the recent turmoil unleashed by New York Community Bancorp, Japan’s Aozora Bank and Germany’s Deutsche Pfandbriefbank as they took steps to brace for bad loans. 

In Manhattan, brokers have started to market debt backed by a Blackstone-owned office building at a roughly 50 per cent discount. A prime office tower in Los Angeles sold in December for about 45 per cent less than its purchase price a decade ago. Around the same time, the Federal Deposit Insurance took a 40 per cent discount on about US$15 billion in loans it sold backed by New York City apartment buildings.

It’s a turning point for the market as the Federal Reserve ends the fastest pace of interest-rate hikes in a generation – providing more clarity to real estate investors on where borrowing costs stand. Some property owners will have little choice but to sell as their debt come due: More than US$1 trillion in commercial real estate loans are set to mature by the end of next year, according to data firm Trepp.

There have already been major real estate deals that have gone belly up--borrowers simply defaulting and handing their buildings over to the lenders. In cases such as these everybody loses. 

San Francisco’s tourism board launched a $6M ad campaign to overcome the city’s global reputation as a drug and crime-ridden hell hole. Six days later, the owner of two of the city’s biggest hotels announced it was abandoning them because it lost faith that the city can recover. pic.twitter.com/uaZRXWpD3R

— Michael Shellenberger (@shellenberger) June 6, 2023

For years, lenders have employed the so-called “extend-and-pretend” strategy, focusing on lengthening loan terms during periods of turmoil while ignoring short-term valuations. It worked well during the pandemic, when they faced delinquent loan payments as offices, stores and hotels emptied out. It didn’t make sense taking giant cuts on loans, since it wasn’t clear whether the issues were just a short-term, pandemic-related blip.

Unfortunately for them, the crisis gave way to runaway inflation and eventually, a series of interest rate hikes that sent the paper values of buildings plummeting. The problem is exacerbated across the office sector, which hasn’t recovered from record vacancies spurred by remote work. That issue is particularly acute in the Americas, where return-to-office metrics are lower than in Europe and Asia, according to real estate brokerage Jones Lang LaSalle.

While prices for offices have tumbled in financial centres from London to Tokyo, US cities have seen particularly big declines. San Francisco, which for years benefited from booming demand from tech companies, had the country’s highest rate of available office space in the fourth quarter, at 37 per cent, according to brokerage Savills. New York is faring better, with a more diversified tenant base including financial services, legal and media firms, but nearly a fifth of its office stock is available to rent.

Even as building values in those areas slump, prices would have to decrease more for transaction activity to reach normal levels, according to MSCI Real Assets.

The plunging US values are being felt around the world because properties in top-tier American cities were once magnets for global investment. Offices were seen as super safe bets backed by high-quality assets with long-term leases and rising rents. That’s now coming back to bite.

Government officials--Janet Yellen and Fed Chair Jerome Powell say the problem is manageable, so don't worry. But then again, we are talking about Janet Yellen and Jerome Powell, who haven't exactly been amazing stewards of the dollar. 

If a financial crisis does arise out of this crash in commercial property values, it will be on top of a brewing crisis in China on real estate. 

"Evergrande’s rapid rise was enabled by its aggressive borrowing and unconventional fundraising. Its aggressive use of leverage made it the world’s most indebted real estate developer," writes @ZongyuanZoeLiu. https://t.co/tVpRf4g6DX

— Council on Foreign Relations (@CFR_org) February 15, 2024

All in all, things are looking pretty awful both here and abroad, and with the economies of the world deeply enmeshed the results are obviously unpredictable. 

For every 20 predictions of doom, about 5 come to pass, so I claim no certainty about what will happen in this case. But the conditions are ripe for a disaster, and at a minimum, you can expect the Fed to make moves that will cost American consumers a lot in the long run. 

Would any of this have happened with better governance? Probably not. Lots of people are at fault. Investors, of course; local politicians; COVID mandate idiots who didn't think twice about upending our economy. And, of course, the Fed. 

Unfortunately we are at the mercy of all these forces. Expect a rough ride.