Tuesday Already? Powell Speaks and REITs Tumble

The shift towards remote work has led to a significant decrease in the number of workers in downtown offices, negatively impacting investments tied to downtown Real Estate and Public Transportation. As a result, Bonds linked to New York subways and buses are being undervalued, and downtown-focused Real Estate Investment Trusts are trading at less than half of their pre-pandemic levels. Investors are, in turn, demanding higher interest rates to hold office-building debt. These trends have implications for city finances, as they strain traditional revenue streams such as Property Taxes, Taxes on Wages Earned within city limits, and Fares from office workers’ commutes.

The decline in downtown investments also has social consequences, with cities facing budget gaps and potential austerity measures. Public spaces are emptier, and there are concerns about an increase in homelessness and the mentally ill occupying transit stops and streets. Analysts are closely monitoring downtown areas and are particularly cautious about debt from certain Northern urban centers and large California cities.

There are already indicators of investor unease, such as higher yields on bonds backed by commuter fares and increased interest rates for low-rated commercial mortgage-backed securities. Defaulted commercial mortgage-backed securities related to office towers in major cities further contribute to the negative sentiment. REITs which focus on downtown office buildings have seen significant declines in share prices.

Lower property values may lead to challenges to tax assessments, potentially reducing tax revenue from office buildings. This presents city officials with the choice of collecting less revenue or increasing the burden on other taxpayers. Office-building property taxes typically account for about 10% of major cities’ revenue but much more in places like Manhattan, where Commercial Space outnumbers Residential. The financial struggles are particularly pronounced for other older Northeastern, Midwestern, and California cities with high debt loads and pension liabilities.

Although cities are not going broke and still house wealthy individuals and companies, the  potential long-term impact of the shift to remote work on city budgets is severe. Cities have already seen declines in spending and revenue, and Federal Aid provided during the pandemic has run out. As a result, Investors are increasingly looking for opportunities in suburban bonds in low-tax Southern and Western states that have attracted companies and workers from Northern cities.

San Francisco, Philadelphia and San Jose, in particular, has been heavily affected by the tech industry’s embrace of remote work and subsequent layoffs. Vacancy rates for office space have increased, and ridership on public transportation has declined significantly – leading to more lost revenues. The city’s budgetary risks have led to credit downgrades, and landlords are appealing for reduced tax values on office properties, potentially reducing property tax revenue.

It’s not just the REITs that suffer – it’s the thousands of businesses that used to feed and service all those office workers – a lot of them are closing their doors as workers fail to return and aid money runs out and Pandemic Loans are called due.  Look at all those cities where less than 30% of the workers show up on Friday (left column) – what businesses are going to survive that loss for a sustained period of time?