Oil demand has held up remarkably well despite many continuing to work from home post-COVID. Gasoline demand in the US rose by 1.7% last week and was 2.3% above the four-week average, according to GasBuddy. If trends continue you would expect to see gasoline demand eclipsing pre-COVID levels even without a major change in commuting patterns, due to several factors such as increased travel amongst retirees. A further tailwind to gasoline consumption could be a push by banks and governments to get people back in the office.
The alignment between several unique actors in getting people back downtown is largely due to commercial real estate trends. Between 2019 and 2021, the number of people working at home nearly tripled based on US census numbers. These are people that no longer travel downtown regularly. Low office occupancies will soon start flowing through to the tax base of major cities and impacting the commercial real estate loans of banks, particularly mid-sized banks which are already under pressure. A recent study by professors at Columbia and New York University had the value of US office buildings potentially falling by almost 40%. Examples of price declines have also been occurring publicly with recent office tower sales in San Francisco being pulled because offers came in so far below expected value. This drop in value is due to a combination of higher rates and lower occupancies.
Small and mid-sized banks hold a significant portion of commercial real estate loans in the US. Federal Reserve data shows almost two-thirds of commercial real estate loans are held in banks outside the top 25. These banks are important to key communities in terms of local lending and are also large employers. Economists and politicians do not want to see them fail. The subset of regional and intermediate sized banks is already under pressure from deposit outflows, post Silicon Valley Bank, with First Republic being the latest potential casualty. The last thing these banks need is their commercial lending portfolio to further impair equity values. How they approach solving this remains to be seen but expect a large chorus of previously quiet stakeholders working to get companies back in the office.
Commercial properties are also a critical part of a city’s tax revenue. Some major North American cities, such as Toronto, also have a commercial-to-residential property tax rate that is above the national average. Meaning that commercial real estate is helping protect citizens from higher taxes. The contributions from commercial property tax rates to total budgets range significantly for cities, given their planning approach, but many sit around 20%. The approaches for deciding on taxes owed also vary by city and region but the main way to think about is that like your home it is based on value. If the value of commercial properties were to drop by the amount suggested in the studies, then your options for running a city are to cut programs or raise other taxes. No politician wants to cut programs and putting more of the tax burden on residents (voters) while they already struggle with a cost-of-living crisis, is likely, not advisable. This means no city wants to see those occupancy levels remain low and commercial real estate values fall.
There is a chance that a concerted effort to support the commercial real estate asset class could be made, given the interconnected impacts on the system we all participate in. For example, Amazon
I do not know how this will play out and don’t have a personal view on what is best for people and cities. The bottom line though is that one of two potential paths will likely occur over the next twelve months. Office vacancies can remain elevated, in which case it will put more pressure on regional banks and city budgets, potentially even resulting in higher taxes for families at the time they can least handle it. The other option is that occupancies increase, either naturally, or with a concerted effort by governments and companies, in which case you likely see a very unexpected tailwind for oil demand.
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