May 1, 2023 - 7:00am
Sitting on the porch of his home, the 99-year-old investor Charlie Munger — better known as Warren Buffett’s sidekick — pontificated on the state of the property market in America. “It’s not nearly as bad as it was in 2008,” he told the Financial Times, in an interview published on Sunday. “But trouble happens to banking just like trouble happens everywhere else. In the good times you get into bad habits…When bad times come they lose too much.”
Munger is not exaggerating. Everywhere you look, there are dire headlines about commercial property. In Canada, for example, analysts expect a 50% decline in commercial property prices. In San Francisco, attempts to sell an empty $300m office tower have some observers predicting that it will end up being sold for 80% less than the investors expected. Meanwhile in Britain, money flowing into commercial property has fallen precipitously.
What is going on? Part of the explanation lies in rising interest rates. With rates rising the property market is getting nervous, as economic activity slows and mortgage and business loans become less affordable. But market idiosyncrasies are another cause of anxiety around commercial property.
For one thing, there has been a lot of overbuilding. If you travel to regional cities in Britain, for instance, empty high-rise buildings are a common sight. Overbuilding has been exacerbated by the lockdowns, which resulted in large numbers of employees working from home, thereby lowering the amount of required office space. Accordingly, vacant office space in Britain has risen by 65% in the past three years.
The economic concerns about these trends are twofold. First and most important is the potential for a collapsing commercial property market to result in mass layoffs. Employment in construction makes up around 5-7% of jobs in Britain. Significant layoffs in the sector would be more than enough to generate a bad recession, much as we saw in 2008-09. The other concern, as Munger alludes to, is the impact that a collapsing commercial property market might have on the banking system.
Commercial properties are rarely financed with cash, and investors almost always take on debt to develop them. If the properties cannot be sold at the planned price, then the loans cannot be bailed out. Banks are already under pressure from rising interest rates and some degree of deposit flight, which has led to several institutional collapses. If commercial property loans go sour, the pressure on the banking system could rise substantially.
A bursting commercial property bubble might also have knock-on effects on the market for residential property. It is almost unheard of that commercial property prices should tank and residential prices remain buoyant. Part of the reason for this is simply because the markets are driven by the same sentiment, but also key is that property is substitutable: if an office building falls in value and residential property is still worth money, an investor can convert the office building into a residential one.
The British economy has been hobbling forward for some time, with economists looking closely as to whether a technical definition of recession has been met. There will be no recession in Britain until there are mass layoffs. More and more, it looks like these layoffs could start in the commercial property sector. And, given the exposure of banks that Munger highlighted, it is likely that these layoffs will be accompanied by a financial crisis.
Philip Pilkington is a macroeconomist and investment professional, and the author of The Reformation in Economics
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SubscribeAnyone interested in politics should start by asking the question: what do I want for the country in the future?
My answer is that all young, married couples in Britain should be able to afford their own home in which to raise a family and all British children should be raised by married parents in their own home.
Not only is that what people want but it would also help to solve lots of problems from falling fertility rates to anti-social behaviour.
One of the things that could help deliver this future would be to convert the obsolete commercial property – offices and shopping centres – into residential property. We have many financiers, architects, lawyers and planners. Get them to work on pulling the regulations together and we can avoid an economic contraction while improving the country.
Better yet, convert them into homes and provide shopping amenities and such on the ground floor. You could potentially provide jobs and homes all in one go.
Completely agree. With a bit of creativity we could build some great neighbourhoods that combine homes, shops, offices and factories.
The essential thing is that the homes become the property of families, not investors renting them out at a profit.
Unlike almost everyone I read of late, I am very optimistic about our future. Home working and online shopping mean: 1. ambitious people no longer need to congregate in the big cities but can spread out around the country and 2. lots of commercial property becomes available for conversion to homes.
Combined with a sensible cap on overall immigration numbers, some laws to prevent property investors hoovering up the gains and financial support schemes for first time buyers we can achieve the dream of every married couple owning their own home. I can’t think of a political ambition more worthy than that.
I very much like your positivity, there is not enough of it about these days.
Thanks Angelique.
Thanks Angelique.
Yes, your point about limits on immigration is good one.
But idea that ambitious people, at least ones early in their careers, don’t want to congregate in big cities is unrealistic.
True but should they buy property there? This sounds right to me: a few years renting in the city, learning their trade, having fun, meeting members of the opposite sex etc. Followed by moving away to marry and buy a house and raise a family while largely working remotely.
There will always be offices in London (as people have pointed out below, many cannot be converted to residential anyway). My firm has space for 2000 people in EC4 and the same in NYC. We barely get 50 a day in either office. It tends to be the younger, junior staff members. We rota senior staff to go in to the office to supervise and train them. When our current leases expire we will move to much smaller offices. All firms will do the same. Eventually only a portion of the current commercial property will be in use. The rest could be flats, shops etc.
True but should they buy property there? This sounds right to me: a few years renting in the city, learning their trade, having fun, meeting members of the opposite sex etc. Followed by moving away to marry and buy a house and raise a family while largely working remotely.
There will always be offices in London (as people have pointed out below, many cannot be converted to residential anyway). My firm has space for 2000 people in EC4 and the same in NYC. We barely get 50 a day in either office. It tends to be the younger, junior staff members. We rota senior staff to go in to the office to supervise and train them. When our current leases expire we will move to much smaller offices. All firms will do the same. Eventually only a portion of the current commercial property will be in use. The rest could be flats, shops etc.
I very much like your positivity, there is not enough of it about these days.
Yes, your point about limits on immigration is good one.
But idea that ambitious people, at least ones early in their careers, don’t want to congregate in big cities is unrealistic.
Completely agree. With a bit of creativity we could build some great neighbourhoods that combine homes, shops, offices and factories.
The essential thing is that the homes become the property of families, not investors renting them out at a profit.
Unlike almost everyone I read of late, I am very optimistic about our future. Home working and online shopping mean: 1. ambitious people no longer need to congregate in the big cities but can spread out around the country and 2. lots of commercial property becomes available for conversion to homes.
Combined with a sensible cap on overall immigration numbers, some laws to prevent property investors hoovering up the gains and financial support schemes for first time buyers we can achieve the dream of every married couple owning their own home. I can’t think of a political ambition more worthy than that.
Perhaps Richard Sharp, late of the sainted BBC would be your man to start this urban revolution?
With a reputed fortune of £500 million, time on his hands, and even a sister who is currently President of the King’s Bench Division of the High Court of Justice in England and Wales, what better choice could there be?
There was a good cartoon in the dear old Guardian
Indeed, it reminded me of ‘Der Stürmer.’
Indeed, it reminded me of ‘Der Stürmer.’
There was a good cartoon in the dear old Guardian
Concur too. The Govt has introduced some Permitted Development Rights (PDs) changes/rights that make it easier to convert to residential, esp to help revitalise town centres. But there are some limitations – all the habitable units must have natural light I think for example, planning issues to do with transport infrastructure and planning gain/levy. But certainly an intention to help push in this direction where it can work.
A problem though will remain for many properties that aren’t as easy to convert or not sited where residential will work as well. A ‘run’ on these valuations could still be highly contagious as we may be not be entirely sighted on who has investment and debt tied up in this sector.
Do you live in London?
Most of the current or fairly new commercial property can not be easily converted into homes.
Never mind family homes and definitely not at affordable prices.
Reality is that unless you stop mass immigration into uk, there is little chance of affordable housing for anyone.
Let’s assume immigration stops tmoro AF. It won’t, but let’s just assume it does for the moment.
How do you provide the homes then fairly quickly?
I did for 20 years. Moved out to Hampshire a few years ago when we had kids.
Yes some can be converted, some can’t. There will always be a need for offices, just not as many as now.
Having far more immigrants than available housing doesn’t help anyone. We need to balance our extra labour needs with our fixed resources- housing stock, public services, infrastructure. Our education policy should include trying to reduce the need for excessive imported labour – e.g. training more medical students. We should be encouraging firms to automate their processes etc.
It can’t be done overnight. But gradually and with political vision we could get to the point where all working families own their own homes. Which would be a massive achievement.
I think it can be done, but would we agree that essentially it’s gone in the opposite direction the last decade and no sign at the moment of a major policy correction?
Even if we massively reduce immigration today the shortage does not correct anytime soon. Converting commercial can play a role in increasing provision but price has to drop significantly for many and that would throw millions of others into negative equity. We’ve got a real conundrum here even when we eventually get to deciding it’s essential we tackle the problem.
I think it can be done, but would we agree that essentially it’s gone in the opposite direction the last decade and no sign at the moment of a major policy correction?
Even if we massively reduce immigration today the shortage does not correct anytime soon. Converting commercial can play a role in increasing provision but price has to drop significantly for many and that would throw millions of others into negative equity. We’ve got a real conundrum here even when we eventually get to deciding it’s essential we tackle the problem.
Let’s assume immigration stops tmoro AF. It won’t, but let’s just assume it does for the moment.
How do you provide the homes then fairly quickly?
I did for 20 years. Moved out to Hampshire a few years ago when we had kids.
Yes some can be converted, some can’t. There will always be a need for offices, just not as many as now.
Having far more immigrants than available housing doesn’t help anyone. We need to balance our extra labour needs with our fixed resources- housing stock, public services, infrastructure. Our education policy should include trying to reduce the need for excessive imported labour – e.g. training more medical students. We should be encouraging firms to automate their processes etc.
It can’t be done overnight. But gradually and with political vision we could get to the point where all working families own their own homes. Which would be a massive achievement.
Better yet, convert them into homes and provide shopping amenities and such on the ground floor. You could potentially provide jobs and homes all in one go.
Perhaps Richard Sharp, late of the sainted BBC would be your man to start this urban revolution?
With a reputed fortune of £500 million, time on his hands, and even a sister who is currently President of the King’s Bench Division of the High Court of Justice in England and Wales, what better choice could there be?
Concur too. The Govt has introduced some Permitted Development Rights (PDs) changes/rights that make it easier to convert to residential, esp to help revitalise town centres. But there are some limitations – all the habitable units must have natural light I think for example, planning issues to do with transport infrastructure and planning gain/levy. But certainly an intention to help push in this direction where it can work.
A problem though will remain for many properties that aren’t as easy to convert or not sited where residential will work as well. A ‘run’ on these valuations could still be highly contagious as we may be not be entirely sighted on who has investment and debt tied up in this sector.
Do you live in London?
Most of the current or fairly new commercial property can not be easily converted into homes.
Never mind family homes and definitely not at affordable prices.
Reality is that unless you stop mass immigration into uk, there is little chance of affordable housing for anyone.
Anyone interested in politics should start by asking the question: what do I want for the country in the future?
My answer is that all young, married couples in Britain should be able to afford their own home in which to raise a family and all British children should be raised by married parents in their own home.
Not only is that what people want but it would also help to solve lots of problems from falling fertility rates to anti-social behaviour.
One of the things that could help deliver this future would be to convert the obsolete commercial property – offices and shopping centres – into residential property. We have many financiers, architects, lawyers and planners. Get them to work on pulling the regulations together and we can avoid an economic contraction while improving the country.
An unconvincing and rather weak article.
“Banks are already under pressure from rising interest rates”.
It is well known that banks do better at higher interest rates than lower ones as the lending spread widens.
Some banks are under pressure because they were poorly managed.
The idea that there is a definitive and immediate correlation between commerical and residential property markets seem dubious. Conversion of commerical property to residential takes both planning permits and significant time.
No mention at all on the secular decline in the need for office space due to working from home.
No breakdown of the construction workforce between commercial and residential property. Nor acknowledgement that there has been a longstanding shortage of builders for home projects whihc might absorb some of any losses. No realisation that part of the construction workforce is foreign.
It is not true to say as a general remark that banks do better in high interest rate environments. They can in the early stages as they attract more deposits, but the other side is risk on lending and that increases significantly with rising interest levels. And later, the banks start to struggle with cost of deposits – the amount they have to pay to fund their activities – and rising costs generally.
A troubled article, and one thing leaps out at me:
”but also key is that property is substitutable: if an office building falls in value and residential property is still worth money, an investor can convert the office building into a residential one.”
This just is not the case really. The old ‘Loft Conversions’ worked because the old industrial buildings worked for it. Modern Office Buildings just do not.
It is like if trucks were in excess but cars not – both vehicles, but not convertible. Putting seats in the back of the truck is not making a car.
You make many great points.
However, I am not convinced that commercial property market is sustainable at current and rising interest rates.
Even residential property at current prices is only viable (at least in London where I live) with permanent immigration into UK of 400k per year.
People forget that till financial crisis of 2008, interest rates were about 5% and much more in 90s (never mind 70s or 80s).
We had 15 years of close to zero of interest rates and unless we are allowed inflation to go unchecked, the squeeze will continue…
It is not true to say as a general remark that banks do better in high interest rate environments. They can in the early stages as they attract more deposits, but the other side is risk on lending and that increases significantly with rising interest levels. And later, the banks start to struggle with cost of deposits – the amount they have to pay to fund their activities – and rising costs generally.
A troubled article, and one thing leaps out at me:
”but also key is that property is substitutable: if an office building falls in value and residential property is still worth money, an investor can convert the office building into a residential one.”
This just is not the case really. The old ‘Loft Conversions’ worked because the old industrial buildings worked for it. Modern Office Buildings just do not.
It is like if trucks were in excess but cars not – both vehicles, but not convertible. Putting seats in the back of the truck is not making a car.
You make many great points.
However, I am not convinced that commercial property market is sustainable at current and rising interest rates.
Even residential property at current prices is only viable (at least in London where I live) with permanent immigration into UK of 400k per year.
People forget that till financial crisis of 2008, interest rates were about 5% and much more in 90s (never mind 70s or 80s).
We had 15 years of close to zero of interest rates and unless we are allowed inflation to go unchecked, the squeeze will continue…
An unconvincing and rather weak article.
“Banks are already under pressure from rising interest rates”.
It is well known that banks do better at higher interest rates than lower ones as the lending spread widens.
Some banks are under pressure because they were poorly managed.
The idea that there is a definitive and immediate correlation between commerical and residential property markets seem dubious. Conversion of commerical property to residential takes both planning permits and significant time.
No mention at all on the secular decline in the need for office space due to working from home.
No breakdown of the construction workforce between commercial and residential property. Nor acknowledgement that there has been a longstanding shortage of builders for home projects whihc might absorb some of any losses. No realisation that part of the construction workforce is foreign.
Commercial properties are often not convertable to residential use. The health requirements, especially for fresh air/open windows just can’t be met by most modern office buildings. Only the outer ring of each massive floor has any exposure to the real world.
Of course, there are many office buildings with floor areas small enough that creative solutions could be worked out. But most, including the newest ones are just not right for residential use.
Marijuana farms and artist studios aren’t gonna pay the mortgage.
Commercial properties are often not convertable to residential use. The health requirements, especially for fresh air/open windows just can’t be met by most modern office buildings. Only the outer ring of each massive floor has any exposure to the real world.
Of course, there are many office buildings with floor areas small enough that creative solutions could be worked out. But most, including the newest ones are just not right for residential use.
Marijuana farms and artist studios aren’t gonna pay the mortgage.
A modern planning system would ensure that all buildings are easily converted between office and residential use.
A modern planning system would ensure that all buildings are easily converted between office and residential use.
It would not be necessary to convert dedicated commercial buildings into residential accommodation. Many older houses have been converted into offices. I used to live in Birmingham, and there are whole streets of Victorian houses with gardens which could easily be returned to residential use.
It would not be necessary to convert dedicated commercial buildings into residential accommodation. Many older houses have been converted into offices. I used to live in Birmingham, and there are whole streets of Victorian houses with gardens which could easily be returned to residential use.
Gee, let’s look at what happened:
Pandemic shuts businesses and makes rents unpayable, and many premises close for good. Supply chain and worker shortages due to a myriad of reasons including demands for mandatory vaccinations. What percentage of people are still working from home? By all means lets go green right NOW, so double the price of energy for all. Oh, and then really irritate the Russians – so smart. And by all means send billions to NATO pet and bottomless pit Ukraine. Inflation out of control due to the previous, BUT….Let’s raise interest rates because that will stop inflation. Non-fixed rates are now through the roof as is everything else. Blame the moronic US administration. This is all self-inflicted, but sadly their policies poison the rest of everything.
Gee, let’s look at what happened:
Pandemic shuts businesses and makes rents unpayable, and many premises close for good. Supply chain and worker shortages due to a myriad of reasons including demands for mandatory vaccinations. What percentage of people are still working from home? By all means lets go green right NOW, so double the price of energy for all. Oh, and then really irritate the Russians – so smart. And by all means send billions to NATO pet and bottomless pit Ukraine. Inflation out of control due to the previous, BUT….Let’s raise interest rates because that will stop inflation. Non-fixed rates are now through the roof as is everything else. Blame the moronic US administration. This is all self-inflicted, but sadly their policies poison the rest of everything.
With massive overpopulation I doubt that the residential property sector will suffer these issues at all in the foreseeable future.
There isn’t massive overpopulation. Births are not even at replacement level in the UK. You’ve been sold a pup…
You are right natives are not.
But 3rd world savages are flooding the country.
I guess they should be put up in mud huts or whatever…
You are right natives are not.
But 3rd world savages are flooding the country.
I guess they should be put up in mud huts or whatever…
There isn’t massive overpopulation. Births are not even at replacement level in the UK. You’ve been sold a pup…
With massive overpopulation I doubt that the residential property sector will suffer these issues at all in the foreseeable future.
As people increasingly move into urban areas, it should make complete sense to build upwards in terms of housing while leaving actual houses for those in suburban and more rural areas. That way you would be able to either replace or refurbish these commercial buildings where some are wholly residential and others part residential and part commercial. You could also place shopping, retail and/or entertainment amenities on the ground floor for example in some cases too.
“…you would be able to either replace or refurbish these commercial buildings where some are wholly residential and others part residential and part commercial. You could also place shopping, retail and/or entertainment amenities on the ground floor for example in some cases too.”
Bingo! 15-minute city block right there! All we would need are the walls and the gates…
Hopefully minus that last bit (I still don’t understand the logic of Councils doing that), but overall I think the idea is sound.
Hopefully minus that last bit (I still don’t understand the logic of Councils doing that), but overall I think the idea is sound.
“…you would be able to either replace or refurbish these commercial buildings where some are wholly residential and others part residential and part commercial. You could also place shopping, retail and/or entertainment amenities on the ground floor for example in some cases too.”
Bingo! 15-minute city block right there! All we would need are the walls and the gates…
As people increasingly move into urban areas, it should make complete sense to build upwards in terms of housing while leaving actual houses for those in suburban and more rural areas. That way you would be able to either replace or refurbish these commercial buildings where some are wholly residential and others part residential and part commercial. You could also place shopping, retail and/or entertainment amenities on the ground floor for example in some cases too.