Wall Street Sours on America’s Downtowns

The pessimism from investors who bet on office buildings and mass transit can be seen in market signals that are flashing red

A building in Midtown Manhattan. On average, offices in major metro areas have half as many workers compared with before the pandemic.BESS ADLER FOR THE WALL STREET JOURNAL

By Heather Gillers - June 20, 2023 12:01 am ET

Wall Street is betting against America’s downtowns.

Investors are paying less for bonds linked to New York subways and buses. Downtown-focused real-estate investment trusts trade at less than half their prepandemic levels. Bondholders are demanding extra interest to hold office-building debt. Downtowns have been a mother lode for American cities over the years, providing billions of dollars in tax revenue along with their distinctive skylines. In turn, investors who bet on downtown office towers, or on the trains and buses delivering workers to them, could generally trust they held a winning hand.

Now, with white-collar workers spending more time in their home offices, a phenomenon that shows few signs of ending, investments linked to downtowns are trading at falling prices in volatile markets.

“You could see this as a slow-motion change or as the beginning of a slow-moving train wreck,” said Richard Ciccarone, president emeritus of Merritt Research Services, a municipal credit-analysis firm. “I hope it’s not a train wreck, but it could be.”

Investors’ dimming view of downtowns isn’t good news for cities’ finances, nor for their residents. It puts under strain some of city governments’ traditional ways of extracting wealth: collecting property taxes on office buildings, taxes on wages earned within city limits, and fares from office workers’ commutes.

Residents of some cities are bracing for austerity. Many New York library branches expect to close an additional day each week under cuts proposed as the city faces rising labor costs and budget gaps projected to reach $7 billion in 2027. From New York to Chicago to San Francisco, residents and visitors complain about empty downtown streets and transit stops that have become way stations for the mentally ill and homeless.

City vs. suburb

Analysts at Asset Preservation Advisors, a municipal-bond management firm, are watching downtowns closely. The team remains confident of certain tax-backed bonds sold by New York City and Boston, but has grown wary about debt of some other Northern urban centers and big California cities, even bonds backed by those cities’ full taxing power.

“The suburbs are going to be one of the big winners in this, and the potential losers could be the large cities that have depended on people coming back and forth to work,” said Ken Woods, founder and chairman of the firm.

Office buildings are only about 50% as full as before Covid-19 across 10 major metro areas, according to keycard tracking by Kastle Systems, a building-security company. Federal transit data show public-transportation ridership at less than 70% of pre-Covid levels in major metro areas.

President Biden said more than a year ago it was time for America to get back to work “and fill our great downtowns again.” Yet even in the federal workforce, more than half of employees worked remotely at least one day a week last year, according to one survey.

One indication of investors’ wariness of downtowns can be seen in how they price bonds backed in part by commuter fares. The lower a bond’s price, the higher its interest yield. In New York, some bonds partly backed by bus, subway and commuter-train fares yielded a lofty 1.25 percentage points above top-rated municipal bonds on June 14, a spread 56% wider than before Covid, according to ICE Data Services, a financial analytics company.

While the bonds remain investment grade and many asset managers are comfortable holding them, Asset Preservation Advisors has stopped buying fare-backed debt of the New York Metropolitan Transportation Authority unless it matures relatively soon.

In another indication of investor worries, those who buy a common type of low-rated commercial mortgage-backed security are demanding 9.25 percentage points more interest than that on 10-year Treasurys as of June 12, according to research from Bank of America. This spread is three times as big as before the pandemic for such securities, which finance a property mix that is around 30% office space.

Originally posted in The Wall Street Journal - June 20, 2023 12:01 am ET