The real estate bust America’s suburbs need

IN ALL the banking turmoil of the past two weeks, the commercial real estate market has come into focus as another at-risk sector stressed by high interest rates. But while banks and investors sweat the potential for losses and loan defaults, there is a silver lining for certain places, including suburban enclaves that have exploded in growth and become more affluent over the past decade.

Decaying but not-quite-dead-yet assets, such as big office complexes, have been holding back transformations needed to support expanding populations. Their failure would ultimately be a benefit to their communities, which have been building toward this moment since the fallout from the 2008 recession.

The caveat in this discussion is that every place with a vacant office building will not necessarily be in a position to redevelop or transform that parcel of land. If there is no population or wealth growth in the area, a vacant building is probably going to just remain vacant. And in urban environments – such as downtown San Francisco or Midtown Manhattan, where there are arguably gluts of office space even though land is valuable – it may take years for landowners and the surrounding communities to figure out how to work through a transition.

The sweet spot for the activity I am talking about is suburban communities such as the ones you find in Dallas, northern New Jersey and Orange County, California. These have seen an influx of residents and surging home values over the past decade, while the existing property environment, particularly for commercial, is ageing, low-density and relatively low-quality. They are the kinds of places that were hit hard by the 2008 recession. They muddled through for the next five years while coastal cities became the darlings of the economy, with millennials flocking to the abundance of urban amenities and well-paid knowledge jobs.

Though the suburbs were not trendy during those years, the time was not wasted. Residents and local officials gradually recognised that land-use patterns would have to change if suburbs were going to succeed in recruiting millennials as they aged into the family phase of their lives. Zoning codes were changed to allow mixed-use development, rather than just single-use office or retail. In many cases, communities added walking and biking trails. Coffee shops popped up and dining options improved.

But commercial property takes time to turn over, and municipalities are powerless to do anything but wait for an ownership change. In the 2010s, there were commercial parcels that were in a great position to be redeveloped but remained stagnant. As long as tenants continued paying their leases, property owners held properties for their cash flow, which was compelling at a time when interest rates were low and investors were searching for yield.

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The pandemic, rising interest rates and the growing prospect of a commercial real estate downturn now may present the catalyst to turn many of those parcels over for redevelopment. Consider, for example, a project already under development called Medley, in Johns Creek, Georgia, about 32 km north of Atlanta. It was originally an office complex for State Farm Insurance, with two office buildings surrounded by an ocean of 2,200 parking spots on 22.2 ha of land.

After falling vacant, the property was rezoned to the city’s new mixed-use classification and now is the site of a US$350 million project that will include 900 residential units, 200,000 square feet (sq ft) of space for retail, dining and entertainment, and 110,000 sq ft for office space. The two-storey office building will be torn down, while the four-storey one will be repurposed.

This and other redevelopments are benefiting from lessons learned over the past decade, as suburban malls were struggling, and urban centres were thriving.  Local leaders have figured out what level of density and urbanisation they want and where they want that activity to occur. They have identified which parcels are ripe for redevelopment. To make their vision real, they just need properties to change hands.

Cities, on the other hand, find themselves in the position suburbs were in after 2008: grappling with the bust in the commuter-office economic model and how they want to move forward.

This suburban commercial transformation will take time and could be further delayed by more economic upheaval. Community banks may end up tightening credit standards in the fallout from the implosion of Silicon Valley Bank, and higher interest rates or a broader economic downturn could lead to less construction for a while. But these ageing, dying-but-not-quite dead commercial properties were an albatross for many communities, and they will be eager to finally have a chance to replace them – with new developments that represent the future rather than the past. BLOOMBERG