The U.S. commercial real estate (CRE) sector has been facing a crisis for a few years. The pandemic, rising interest rates, falling property values, and increased CRE management costs have become the ingredients for the perfect storm that could lead to such a crisis. With over $1 trillion in CRE loans maturing in the next two years and property values continuing to decline, banks —especially small and midsize ones— are feeling the strain. A CRE sale hit the headlines recently after a well-known Manhattan office block sold for $8.5 million at a heavy 97% discount. Despite plans in some firms to return to the office, vacancies and falling property values have left many CRE investors exposed to significant losses, creating a ripple effect of financial instability.

As the trend seems set to continue, can this looming crisis be averted?

A 97% discount on prime commercial real estate

In July 2024, a 23-story office building at 135 West 50th Street in Midtown Manhattan, originally bought for $332 million in 2006, was sold through an online auction for $8.5 million, marking a 97.5% discount from its last sale price. The property encompasses 925,000 square feet of office space and was redesigned by the renowned Gensler Architects.

Despite its prominent location and history of hosting companies like Zales and Sports Illustrated, the building is currently 65% vacant, largely due to the pandemic’s impact on CRE. The sale did not, however, include the land beneath the building, which was sold separately to Safehold in 2019 for $285 million.

Why is commercial real estate taking a hit?

Since the COVID-19 pandemic in 2020, there has been a seemingly permanent shift towards remote working, resulting in a growing abandonment of large buildings used primarily as offices. Around 30-35% of employees now work from home, following an accelerated move away from traditional office-based schedules. This has, in turn, drastically reduced the demand for leased office space, creating a surplus and driving up vacancy rates.

In the cases where commercial real estate is needed, many older buildings are suffering, struggling to stay competitive as they lack the infrastructure to add the modern, tech-based amenities that tenants seek today. This was another downside of the 135 West 50th Street property, which was older and more dated than many newer buildings nearby, despite recent lobby and elevator upgrades.

Repurposing commercial real estate

Many former commercial properties have now been transformed into private homes and apartments, which is a viable solution to the challenges faced by the CRE sector. While this option may be suitable for smaller buildings, it often poses a challenge for larger, multi-story buildings such as those available in Manhattan and other built-up cities. Many were originally designed with layouts that aren’t easily adaptable for residential use.

For instance, large interior spaces often lack windows, making them unsuitable for livable rooms and posing a challenge regarding compliance with safety regulations. These buildings may also have structural designs and access limitations that complicate conversions, such as insufficient plumbing infrastructure, restricted elevator capacity, or zoning regulations. Even if a conversion is possible, it is a hugely costly endeavor and may make the entire investment less profitable in the long run.

Is a looming commercial real estate crisis avoidable?

Some argue we’re already experiencing a commercial real estate crisis. Many cities aren’t the poles of industry they once were. Globalization has also made it possible and probable for businesses to employ staff in other regions and countries, thanks to video calling, email and payment processors allowing for fast cross-border payment, reducing the need for physical spaces in which to house employees.

As for the most affected areas, banks and businesses will need to put proactive measures in place to avoid a major crisis. Some experts suggest extending debt maturities and securing multiple sources of liquidity. But it is also important that stakeholders acknowledge the permanent shift in office space demand due to remote work, and update property valuations accordingly to avoid overestimating asset values.

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