As most of you know now, the response to the Covid-19 pandemic by The Fed and U.S. government created about $6 trillion in new money, which it pushed into the U.S. economy. The reason was to buoy up the economy during the mandatory lockdowns. All this money put the Retail Apocalypse, the closing of thousands of retail stores in the last decade, on hold for three years or so. Now that consumers have hit the wall financially, the Retail Apocalypse is gaining steam again.
This video lists over 5,200 individual store closings that have already been announced, and most of them will happen this year. These are not all of the companies closing stores down, just 15 of the big ones.
While that $6 trillion in newly created money made most of us Stimulus Ballers for a while, that money has been spent by consumers, who are now largely broke, and saddled up with high debt again. That means that ginormous amount of money has mostly flowed into the investment world, where major corporations and ultra wealthy individuals invested it in "assets." Those assets, which have soared in value since 2020, are stocks in the U.S. stock market, residential real estate, and some other assets like crypto, and collectibles, to a much smaller degree.
Along the way, when everyday people were flush with cash, retail stores caught a break, and the Retail Apocalypse got put on hold for a while. People had money, some were hitting brick and mortar stores regularly, and they stayed in business for a while longer. But the recession that started in 2020, then got put on hold by all that new money, is setting in again. This time there's nothing visible to stop a recession from happening. The main economic countries of the world, China, Japan, Europe, and the U.S., are all slowing down, and consumers are struggling worldwide. That has, once again, slowed down sales in the tradition brick and mortar stores retail world, and thousands of stores are closing down again.
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This 60 Minutes segment, from February 2024, gives a pretty good overview of the basic idea of this post, the current state of cities. There's a HUGE crisis brewing right now in commercial real estate. Anyone who follows financial markets or real estate knows about it. There's no "if" about it, it's something that will wreak a lot of havoc on many levels, at some point. It's happening now, and the biggest crisis moment hasn't hit yet. Everyone knows it's coming, it will affect the whole economy, and every single person's life in some way. And no one really knows what to do about it, this issue is that big
Black Swans and White Swans
What is a "White Swan" event? In 2007, Nassim Nicolas Taleb wrote a book called The Black Swan. The basic idea of a Black Swan Event is something that has a very low probability of happening, but has a huge impact if it does happen. A meteor 100 yards wide hitting your city is an example of a Black Swan Event. The chances of it happening are very, very, very low. But if a meteor that size did hit your town, it would leave a crater several city blocks wide, and cause massive devastation for miles in every direction, on people, businesses, infrastructure, and the local economy. It would be catastrophic to a city. By its very nature, a Black Swan Event is unexpected, it's something almost nobody sees coming.
His basic idea concerning investing, as I understand it, is to protect yourself (and your investments) against potential black swan events. Having fire and flood insurance on your house, because of the tiny chance those things might happen, is an example of protecting yourself, and your house, against the small chance of a fire or a flood. If those things happen, the insurance covers the value of your house, so you can rebuild. So that's the "Black Swan" idea in a nutshell. The Covid-19 pandemic is a great example of a Black Swan event. Yes, a few virologists, and Bill Gates, knew something like that would happen eventually. But to almost everyone, it was completely unexpected, and had devastating consequences, killing over 7 million people worldwide, and over 1.2 million in the U.S. (source: Worldometer). That's the largest recent example of a Black Swan Event.
By contrast, a "White Swan Event" is something that has a high probability of happening. It will still be catastrophic, but we see it coming, we have time to prepare, if we want to. The commercial real estate crisis is happening, slowly, steadily, and the whole business and economic world sees it coming. But no one really seems to know what to do, other than slow the process down as much as possible. But it's still going to be a major crisis at some point. Soon.
This is a huge issue, it will affect your bank, maybe even your own checking account, and it will affect the value of the home you own, or the home or apartment you rent. It's big, it's complex, and the crisis is moving really slowly, which makes it easy to ignore in our busy, everyday lives. But, like it or not, it is going to happen, we know it's coming. How will it affect your life? How can you either deal with your part of this crisis, or maybe even profit off of the chaos? That's the question a lot of smart people in real estate, banking, economics, and finance are trying to figure out these days.
This is a blog post, not a book, and commercial real estate a complicated, complex issue, so I'm going to try and explain the big picture in as little writing as possible. I'll start with the really big picture, and work down to how this affects the offices and apartment buildings in your own city or town, in your own neighborhood. As I'm writing this blog post, there's a junk hauling truck across the street, and a few guys have been carrying the fixtures and "guts" out of a recently vacant, second floor office, and throwing them in a truck, while I've been sitting here. This is happening in every city and town across the U.S., and many other parts of the world as well.
The Big Picture. If you have read any of my economic posts over the last 5 or 6 years, you know I have this Big Picture concept that I call The Big Transition. The basic idea is simple, The Big Transition is the concept that our society is in a long transition phase, we're moving out of the Industrial Age, and into the emerging Information Age. That's it. The basic idea is that simple, the Industrial Age began to fade about 65 years ago, very slowly at first. This idea was first explained well by the late futurist Alvin Toffler, in his 1980 book, The Third Wave. You can click the link for more detail on that. But let's keep it simple right now. The Industrial Age society began to break down many years ago, slowly, and the Information Age began to emerge. We are in a long transition phase between the two, at least 80 or 90 years total. That's where this crisis begins.
The Spatial Fix
The next part of the commercial real estate crisis is called the Spatial Fix by geographers. This is another big concept most people are not familiar with. But here's the simple, underlying idea. Every type of society, over decades, builds the types of buildings and infrastructure it needs to function. The Industrial Age began 350 or 400 years ago, emerging from the Agricultural Age, where most people lived and worked on farms. Over those 350+ years, factories were built, smaller businesses rose up around the factories, and around the mines, and the natural resources the factories needed. Small towns, and cities of many different sizes, emerged. Houses were built in those towns and cities, and eventually the suburbs, where factory and office workers lived. In the bigger cities, lots of large office buildings were built as well, forming the skyscrapers of the downtown districts of the larger cities. That was the Spatial Fix out of the Agricultural Age, into the Industrial Age. The Spatial Fix is the changing from one set of buildings and infrastructure to another. In our case, the Spatial Fix is the shift from the buildings and Infrastructure needed for the late Industrial Age to the buildings and infrastructure needed for the early Information Age.
In our late Industrial Age, the 1970's, for example, people lived in houses and apartments, worked in the factories and offices, shopped in grocery stores, shopping centers, and malls for their goods, and drove on local streets in town, and larger, interstate freeways between the cities and states. Every town, even small ones, had at least one factory, often more, and these were spread across the country, in towns of many sizes. Cities built the basic infrastructure and services needed, like electricity, water, and sewage systems. They also hired people for local government jobs, like police, firefighters, city workers, and trash collectors, that were needed to keep the city going.
This Industrial Age version of the United States peaked in about the 1960's and 1970's. Then, a whole range of new technologies came into play, big mainframe business computers, data processing, satellite and cable TV, wireless phones, industrial robots, cell phones, personal computers, the internet, and so on. Technology began to take over a whole bunch of human jobs, and change the way we worked and lived our day to day lives.
Because of all this technology, we were able to live much different lives. This is the key point here. We could communicate with millions more people, much cheaper and easier, with cell phones, the internet, and social media. We could share information in talk, text, photos, and video. We could move digital money around much faster than gold bars, dollars bills, or checks in previous eras. Our entire ways of life began to change as one technology after another became operational in our lives. This allowed all kinds of different types of new businesses, jobs, and work to emerge.
But there is a huge problem with this. We still had the basic buildings and infrastructure for Industrial Age life, but much of the technology of the emerging Information Age. When the factories began shutting down across this country, in the late 1970's and early 1980's, many cities became much less functional, they lost their main employers of many residents. We, as everyday people, had some of the technology of the coming Information Age, but we didn't have all the needed technical and physical infrastructure of the Information Age built yet. We had a new system with old hardware, in a sense. Our society and our way of life has changed much faster than our physical buildings and infrastructure. High technology became one of the best paying industries, but tech companies tend to cluster in a small number of large cities, they are not evenly spread out across the nation, like industrial factories were. That complicated the transition even more.
This led to two very different types of urban problems. The initial tech hub cities, originally Silicon Valley (San Jose/San Francisco Bay area), Boston, Seattle, Los Angeles/SoCal, Austin, Texas, Raleigh/Durham/Cary, and the Washington D.C. area, they saw huge growth in tech businesses, and had lots of high paid workers rise up in their regions. These high wages caused home prices and rents to soar. All those tech businesses used a lot of office space as well. Over time, more tech grew up in New York City, as well. So these regions struggled to find enough qualified tech and creative workers and good office buildings. Home prices and rents rose to levels that were hard for workers making average levels of pay to afford. So we had cities with thriving tech business, a thriving office real estate market, and high home prices and apartment rents.
Then there's the rest of the country. Most cities and towns across the U.S. had the opposite problem. Most of the factories that people worked at shut down, or their jobs were taken by industrial robots or other technology. Millions of low and medium skilled workers lost good paying factory jobs. Real estate prices dropped in those cities, and many residents left to find jobs in larger metros. Many places became "Eds and Meds" cities, with the local colleges or universities (education), and hospitals (medical), becoming the largest employers in the area.
Some cities lost tens of thousands of residents over a decade or two. Extreme cases, like Gary, Indiana, for example, wound up with over 10,000 empty houses, high crime, and plummeting real estate values. Why? Gary was built around a single huge steel mill, and the mill shut down. The thriving Industrial Belt of the Great Lakes region, where I grew up as a kid, has turned into the Rust Belt. Now 20-year-old UrbEx explorers make YouTube videos, wandering around the remains of the crumbling factories. Those were factories that I remember being busy, often working two or three shifts, when I was a kid. This change has already wreaked havoc on most of these towns and cities.
There are probably 150 or 200 American towns and cities struggling to re-invent themselves, bring in new employers, and create good paying jobs for their residents. They have reasonable rents and home prices, but they haven't been able to create large numbers of high paying jobs for 30 or 40 years. As people moved out, less people went shopping, and more people shopped online, aided by the internet, digital banking, and other technologies.
This combination of factors led to the Retail Apoclaypse, with somewhere around 30,000 individual stores closing down, between 2010 and today. All of those stores closing led to dead malls and dead shopping centers. I was born a few miles from the site of Rolling Acres Mall, in the video linked., and the first dead mall to really get famous back in about 2014. Remember The Big Transition idea? We're moving from the fading Industrial Age into the emerging Information Age. More people shop online now, and we don't need as many brick and mortar stores, so lots of stores started closing down. Not all stores are closing, but a lot of them are, particularly in the towns and cities that lost factories years ago. Following the closure of the factories, and outward migration of hundreds of thousands of people from former industrial cities, retail business slowed down in those towns and cities. Yes, this is an over-simplification, but it's a major factor in most of those store closures.
This is all part of the Spatial Fix. In the 1970's, we had all the basic infrastructure needed for the late Industrial Age. But we didn't have the infrastructure needed for the Information Age that we were about to head into. We had factory buildings that were no longer needed. We now have malls and shopping centers that are no longer needed in many places. We have tens of thousands of houses in small towns and mid sized cities that are no longer needed.
At the same time, we needed to build cell phone towers so our cell phones would work. Those got built. Also at that time, we needed to build huge data storage centers for computer systems and the internet. Those got built. The Spatial Fix is the process of old buildings (houses, factories, office buildings, government buildings, colleges, urban infrastructure) becoming obsolete, while new types of buildings and infrastructure get built in the places where they are needed and make sense. This is a very slow process, it takes decades to happen. We needed cables laid for cable TV, and later, we needed fiber optic cable networks for the initial internet. Those got built. Huge tech campuses for tech companies like Apple, Microsoft, and others, got built. Now we are getting thousands of satellites launched to fill in the blank spots of internet service. Those are part of the Spatial Fix, new types of infrastructure getting built, so the Information Age can keep growing and evolving.
We need LOTS of affordable housing in the tech hub regions. Not just apartments for growing number of homeless people, at least 90% of the population needs "affordable" housing, at many different levels of affordability. Not many people want unaffordable housing. So we need types of housing, from apartments for a few hundred dollars a month, to big, $600,000 houses for growing families of people working high paying jobs. We have huge mismatches in where houses are, that are no longer needed, and where we need lots more houses and apartments at reasonable prices. For example, right now, you can find a 3 bedroom, 2 bath house in Gary, Indiana for sale for under $25,000. I'm not kidding. It's not just Gary, Indiana. Here's another 3 bedroom 2 bath house for sale, for under $25,000, in Mansfield, Ohio. That's the city where my mom grew up, and where I visited a lot as a kid. On the other end of the spectrum, you can find a 3 bedroom, 2 bath house in Cupertino, California, close to Apple Headquarters, for just under $3,000,000. This is the difference between a once thriving Industrial Age city, and a current tech hub, Information Age city in today's world. We have lots of houses in places we don't need them anymore, and not enough affordable houses in places where we do need them.
Part of The Big Transition is the old buildings and infrastructure becoming obsolete for its original purpose, and the transforming or building of all the new types of infrastructure needed, IN THE RIGHT PLACES for the growing and emerging Information Age. This is a time of huge mismatches. We see it in those three homes linked above, and we see it in the job market. It takes decades for a society to sort out these mismatches, and work through all the underlying issues. Part of the problem is that civic leaders, read politicians, don't think long term at all, as a general rule. These underlying issues never even hit their radar. They may try to start jobs programs or get federal funding for a place like Gary, Indiana (or the 150-200 cities with similar issues), and then promote homeless programs in Cupertino (the San Jose, CA region). Politicians allocate money to deal with the symptoms of major problems, but rarely deal with the real, underlying issues. In most cases, they don't really understand the true, underlying issues for long term problems. They are too busy campaigning and fundraising to read a bunch of 400 page books on complex issues. You never hear politicians mention the deep, long term, underlying issues, because it's not good political fodder. Talk about negative issues doesn't get them votes and campaign donations.
As a society, we've dealt with closed down factory buildings for about 45 years now. We've been dealing with dead malls, dead shopping centers, and dead retail stores for about 10-15 years now. You see where this is going? The commercial real estate crisis we are facing right now is just the next step in the overall, nationwide, Spatial Fix. The pandemic accelerated the work-from-home idea, which had been progressing slowly for many years. Now, with a lot more people working from home, another major shift has occurred. Which means we have too many office buildings, and too many industrial buildings, and even too many luxury apartments, in some regions. Like the factory buildings of the 1980's, and dead malls of the 2010's, we need to see how we can adapt as many of these office buildings as possible to different uses going forward.
Office buildings, in general, are hard to turn into apartments, because there are not enough water lines, sewage lines, and other, similar issues. What else can older offices, particularly the smaller and mid sized buildings across the small and medium sized cities of the U.S., be re-used for? If we don't find good answers to this question, then there will be a hundreds more buildings that will become abandoned across the country, in Red States and Blue ones. This will hit cities of all sizes, all backgrounds, and on all levels.
But commercial real estate, the current crisis part of the Spatial Fix, between Industrial Age buildings and Information Age buildings, creates a bunch more issues. This is where the real crisis comes in. First of all, the value of a commercial real estate building depends on how much money the building earns, and less about its physical location, like in residential real estate. When an office building goes from a 5 % vacancy rate to a 20% vacancy rate, the value of the building drops dramatically. Next, office and commercial buildings are usually bought with short term loans, and the owners just pay the interest of the loans, then roll the loan over in 3 or 4 years. They never pay down the principle, like people do with home mortgages, so they have no equity, unless the value of the building goes up. Now, we have buildings with less offices rented out, so the value is going down. The loans are made mostly by the small and mid-sized regional banks. In addition interest rates on loans have risen by about 3% to 4% in the last two years.
So now we have hundreds of office buildings worth less than they were a couple of years ago. Some of these are worth less than the loans now on them. Those 3 and 4 year, interest-only loans are coming due. Since the vacancy rates are up, the owners have less money in general. The banks want more money put up, perhaps millions of dollars, since the buildings are worth less, AND they have to make the new loans at higher interest rates, which means the interest payments on the loans will double or triple in many cases. This means office building owners are going into the bank, which is asking them for more money up front, AND much higher payments on the new loans. The building owners, who are already struggling because the they lave less businesses paying rent in the buildings, often can't afford to run the building with the new higher loan payments.
Now we get to another aspect of modern commercial real estate. Usually each building is set up as its own corporation, and if the building owner stops paying their commercial mortgage payments, all the bank can do is take the building back, they can't go after any of the building owner's other assets to make up the money they lost on the loan. So hundreds of office buildings are now worth much less, maybe 40% to 80% less, since fewer offices are rented out. The current building owners can't come up with more money to create equity in the deal, and they can't run the buildings with the new, higher loan payments. And, in many cases, these building owners, even huge corporations like BlackRock, Brookfield, Vanguard, and similar major commercial real estate businesses, can just hand these big buildings back to the banks. "Here's the keys, we're out! Good luck!" This is already happening, and will happen to hundreds of billions of dollars worth, maybe even trillions of dollars worth, of current commercial real estate over the next few years.
We will soon have banks owning buildings that were worth $10 million in 2021, and may be worth $3 million in 2025. Or buildings that were worth $100 million in 2021, and are worth $25 million in 2024. Banks are in the business of making loans, not running large, complex office buildings, except their own headquarters. So we will get to the point where banks take over these huge buildings, and have to write down losses on those loans, and a many other loans, since most of their other buildings they have loans on will also go down dramatically in value. The banks across the U.S. (and most other major countries), are already struggling. These huge losses will make dozens, probably hundreds, of regional banks insolvent. Even the Big 5 banks will get hit with huge losses, because they have a lot of exposure to huge REIT's (Real Estate Investment Trusts). So a bunch of banks are on the verge becoming insolvent, even if they've been running their banks well, generally speaking. These losses WILL be too much for the system to handle, and we will have another major banking crisis, like we had back in 2008. It's coming. We know it's coming. This has been slowly playing out for over a year already.
Now we get to the point of how this will affect you. If you own several of the types of commercial real estate, there's a good chance it will go down in value, at least for a few years. If you own a business, these bank losses and higher interest rates could lead to higher rent on the building you rent. If you're just an average working person, your bank might become insolvent, and get shut down. Now, you are covered for up to $250,000 by the FDIC. But there's a chance many accounts may be frozen, temporarily, as banks go under, and as each banks issues get worked out. Having your bank account frozen for a week or two would be tough for most people, even if they lose no money. This whole commercial real estate crisis is happening. It's a super low-motion train wreck. And it will stress the already struggling economy, causing a deeper, and most likely, a longer recession. We see this crisis coming, a big White Swan event. It's not going to be easy for anyone.
Now, the final major ripple effect. Cities and towns of all sizes get a big chunk of their revenue from commercial real estate taxes. When buildings go down in value, or sit vacant, they pay less taxes or no taxes at all. So this crisis will lower the money coming into cities, of all sizes, to handle all of their day to day businesses. Yes, cities like New York, Los Angeles, and Chicago will have the biggest losses in value, and will have to furlough or lay off the most workers. But these huge cities have a wide base, and many other sources of tax revenue and stronger political backing. They will struggle, but will, ultimately, be able to survive this crisis better than many of the small and medium size cities and towns across the country.
So far, most of the action to deal with this crisis has been behind the scenes. Banks have been extending loans on buildings, keeping the building owners in business, hoping that the economy would take off, and interest rates would drop back down to near zero, so the buildings would have more space rented out again. That's not going to happen. Not in time to avoid this mess.
Again, this is all part of the Spatial Fix, The Big Transition from the Industrial Age society we're leaving, into the Information Age we're heading into. The late futurist Alvin Toffler dubbed this The Third Wave, and wrote about the various aspects of this issue, from 1980 until 2007. We are moving into another type of society, both technologically and socially, and there's no one group of people that made that happen. This transition began slowly, way back in the 1950's. But now we're in the critical mass part of the transition, where change happens much faster, and on many more levels at once.
There are tough times ahead for almost everyone. That's "baked into the cake" at this point. But, this huge transition period also opens up all kinds of new opportunities, as well. Do you have ideas on how to create more affordable housing in the major metro areas? We need lots of it. Do you have ideas on how to transform old factories, malls, retail stores, or office buildings into new uses for the 21st century? There are huge opportunities for anyone who can figure those issues out. Do you have ideas on how to revive the small and mid sized cities, many of which have been struggling since their factories shut down, 30 or 40 years ago? More opportunity. Do you know how to train out-of-work workers to learn new skills to earn a living in the 2020's? There's a huge number of opportunities there. This whole mess we're heading into is riddled with opportunities to build a better future. That's important to keep in mind.
There you go, this is my best take on the White Swan Event that is the commercial real estate and banking crisis, that we are now facing, as a nation, and as a world. Yes, it seems overwhelming. But it's also the grounds for a lot of future potential to build a better world going forward.
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Steve Rocco. If you were into skateboarding between about 1976 and 2002, that name means something to you.
Rocco was a top pro freestyle skateboarder in the late 1970's and early 1980's. He took the weird, young Florida kid, Rodney Mullen, under his wing, in the early days of the 1980's. In about 1987, Steve started a thing called Santa Monica Airlines, and that morphed into World Industries, the craziest skateboard company ever. The best known version of the World Industries story was told by the 2007 documentary, The Man Who Souled the World.Steve Rocco didn't like how he was portrayed in that documentary, and in this new interview above by Ian at Jenkem Magazine, Steve tells his side of things, more than 15 years later. If you're into skateboarding at all, check this interview out.
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