You’ve probably seen the headlines lately. Commercial real estate is a “bomb” about to go off and take down cities, banks, or both.
But the headlines and many investors and regulators are assessing the risks of commercial real estate all wrong. They talk as if the entire sector is comprised of vacant office buildings in downtown corridors that have been emptied in the post-COVID remote work economy.
The reality is that commercial real estate encompasses diverse products and places that combine to form hyperlocal submarkets. Many of those submarkets — particularly, neighborhood retail and mixed-use developments — are emerging from the pandemic’s disruption stronger than ever. Investors and lenders who lump all commercial real estate together are missing real market opportunities.
While it is true that the market for office space has experienced a big, sticky disruption, demand for the most modern office spaces remains. Vacancy rates vary dramatically across submarkets and within individual regions, and office-using sectors of the economy are demonstrating long-term growth. Even among distressed office assets, a majority of vacant buildings are still revenue-positive or have the potential for conversion to mixed-use
Regulators influence whether office commercial real estate becomes a bomb or not. Currently, they are not giving banks flexibility to extend to commercial real estate borrowers because they fear another failure after Silicon Valley Bank’s collapse last year. This would make sense if there wasn’t a medium-term path for a big piece of the office sector to recover, but flexibility on loan repayment schedules could enable many owners to wait out high interest rates or reposition assets for conversion or modernization.
Giving borrowers leeway in the near term is a more attractive alternative than forcing a banking or municipal finance crisis through rigidity or fear.
Beyond offices, commercial real estate headlines miss a diverse landscape of humble, resilient neighborhood retail assets that demonstrated durability by surviving the rise of e-commerce. Many benefit from new home-based workers who are more likely to shop, eat and play locally. Think about service-oriented businesses that we all still need and use: the local restaurant or coffee shop, grocery store, barber, mechanic, dentist or vet. These are all good bets for commercial real estate investors.
One could go so far as to say the real risks in this sub-class of commercial real estate investment are less about investor overexposure than underinvestment. Millions of entrepreneurs and veteran business owners in neighborhood-serving markets already offer competitive returns. Those returns could grow if they had the capital to expand by either directly acquiring and improving more commercial real estate or accessing operating capital by leveraging land and buildings as collateral.
Investors are missing out on profitable opportunities when they throw away the proverbial neighborhood retail “baby” with the office building “bathwater.” They are also unintentionally redlining Black and brown communities that will be disproportionately impacted by an outflow of already scarce capital.
For example, the Federal Reserve’s 2021 Small Business Commercial Real Estate survey found that even among firms with good commercial real estate scores, Black-owned firms were half as likely as white-owned firms to receive all the financing they sought (24 percent versus 48 percent).
On the residential side, even after controlling for commercial real estate and equity risk, minority neighborhoods were disproportionately likely to receive subprime home mortgages in the years leading up to the 2008 foreclosure crisis. With perfect hindsight into that housing collapse, it is clear that patient and flexible capital would have enabled many homeowners to hold onto their home equity. Entire neighborhoods would not have been devastated, and a generation of Black and Latino or Hispanic assets would not have washed out to sea.
As we contemplate commercial real estate austerity, investors who care about racial justice should keep in mind that supporting local ownership of community assets — businesses, mixed-use developments, and retail — is critical to closing the racial wealth gap. A down cycle is an opportunity to narrow that gap by investing in underinvested Black and brown communities, especially in ways that expand their ownership stake.
Regulators have long recognized that owner-occupied commercial real estate is lower-risk and represents a distinct commercial real estate subcategory. Innovative new models that empower local ownership are ripe and ready to scale, such as fee simple ownership by former tenants, shares in limited partnerships and direct participation in general partnerships.
And, as examples such as Portland’s Community Investment Trust, Chicago TREND, LocalCode Kansas City and Partners in Equity demonstrate, the best part is that co-investing with local stockholders garners community support instead of NIMBY-ism and a shared stake in the growth and prosperity of the investment.
Regulators should be wary of damaging the economy in the name of protecting it. Triggering the commercial real estate “bomb” will hurt elite and institutional investors and owners as well as everyday people in places that have already been traumatized by the pandemic and decades of disinvestment.
Let’s flip the script by investing in commercial real estate in overlooked and undervalued markets while de-risking those investments by turning community stakeholders into stockholders.
Tracy Hadden Loh is a fellow at Brookings Metro. Ida Rademacher is a vice president at the Aspen Institute and co-executive director of the Aspen Financial Security Program.