Post 60: Digging the Hole Deeper and Deeper

 One of the most enduring dilemmas of the past decade has been the “housing affordability crisis.”  The press has churned out story after story detailing how American families are being priced out of the housing market.  A recent article in the Kansas City Business Journal was titled “Kansas City homebuyers now need six figures to afford a house.”  [1]  This headline is a little misleading because a household making $90,000 a year could qualify for a mortgage to purchase a home in Kansas City, it just might have to be a home that is less expensive than the median priced home which is now approaching $400,000.  This is newsworthy because the median household income is closer to $75,000 which means there is arguably a mismatch between income and housing prices.

Credit:  iStock

The general perception that a household making the median income should be able to afford to buy the median-priced house has some rough logic to it, although the actual math is more complicated than it seems on the surface.  The “price” of the median priced home is only part of the issue because the ability of a particular household to afford that home is also affected by interest rates (which have remained stubbornly high), by insurance costs (which have been rapidly rising), and by local property taxes (which have also been trending upward).  A typical mortgage payment includes all three of those costs and yet most articles focus solely on home price as the issue.

That is our first clue to the nature of the housing affordability dilemma.  If all you have is a simplistic understanding of a really complex problem, it is going to be really hard to come up with a good solution.  It is common for people analyzing the problem and proposing a solution to focus on one aspect of the housing market when in fact the issue of housing affordability has many dimensions.  The problem has lots of moving parts and it is easy to get distracted by one small element of the housing market or some short term trend that tends to suggest a pain-free solution.

A recent CMBC article was titled “Nearly one-third of major U.S. housing markets now see falling home prices.” [2]  Pop the champagne!  The problem will solve itself as falling prices restore affordability for the average American.  Of course, that same title implies that prices are not falling in two-thirds of major U.S. markets, so maybe put the champagne back on ice.  Yes, home prices have moderated over the past year or two in some locations, but the forces that are causing that to happen will not come close to solving the problem.  For reasons I will discuss later, the “falling prices” trend is likely to be short-lived because there are powerful forces that don’t really want prices to fall and they will push back until the trend peters out.

That brings us to clue number two in our quest to solve the housing affordability dilemma.  There are a lot of actors who influence the housing market and they are not all pushing in the same direction.  Everyone says they want to solve the housing affordability problem but every actor has their own agenda and their own set of blinders that prevent seeing the big picture.  It even makes it hard to discuss the problem because what I mean by housing affordability is likely to be subtly different from what you mean.  Thus, housing discussions often go in circles because we use the same words but with slightly different meanings.

But here is the real kicker – every actor sincerely believes they are doing the right thing.  There is no deep, dark conspiracy and no greedy genius intent on destroying the American dream of homeownership.  The recurring theme of this article (and a companion article that I will post next month) is that the problem of housing affordability has been caused by organizations and institutions with good intentions trying to do the right thing.  There is an old proverb that says “the road to hell is paved with good intentions” and our current housing problem is a good example.  We think we are helping dig ourselves out of the hole we are in, but in reality we are making the hole deeper and deeper.

Just How Bad Is It?

Pretty bad, but perhaps not quite as bad as many people in the press would have you believe.  Housing tends to be a relatively cyclical market with periodic booms and busts.  The accompanying chart shows that volatility in terms of total housing starts over the past seven decades.  We appear to be coming out of a bubble with housing starts returning to the historic trend line.  Typically, housing prices fall slightly, or at least plateau, during the post-bubble phase – unless it was a really big bubble and then prices fall dramatically (e.g. the 2008 Great Recession).  Unfortunately, I don’t expect housing prices to fall enough to really solve the affordability problem.

Source:  St. Louis Federal Reserve Bank

The worst part of the current situation is that income and housing prices have diverged dramatically over the past 10 to 15 years.  The second chart illustrates that separation (all values are indexed to 2011 = 100 to simplify comparisons).  I am intentionally focusing on median household income and median housing price because I think that is the essential dilemma that we face.  No one thinks that rich people will have difficulty affording a nice home and very few people expect the private market to solve the problem of housing the very poor.  But there is a widespread expectation that the middle class should be able to buy a reasonably nice place to live.  That expectation may or may not be realistic, but in the age of social media perception is reality.  If I work hard and make a decent salary but feel priced out of the housing market, I am going to be unhappy.  As the chart shows, real income has grown by roughly 25 percent while the median home price has nearly doubled.  Our society and our cities need to deal with that reality.

Source:  St. Louis Federal Reserve Bank

The second chart also includes the U.S. Consumer Price Index for housing which is a much broader indicator of what people spend for housing than housing price alone.  That measure tracks much more closely with income until the pandemic hits and then it rises significantly faster than income as well.  There is also the perception that housing affordability is primarily a coastal problem.  It is certainly true that housing affordability is especially bad in Los Angeles, San Francisco, New York, Boston and other big, coastal cities, but it is also a problem in midwestern cities.  In fact, the chart shows that the midwest is slightly worse off than the national average.  There is a lot of variation that is hidden by the averages, but this is a problem that affects just about every city of significant size.

One final measure of housing affordability is the ratio of home prices to income.  According to the Joint Center for Housing Studies at Harvard University, that ratio is at historic highs. [3]  For the 100 largest metro areas, only in the run-up to the Great Recession did the ratio equal current levels.  For the past several years, the average home price has been roughly 5 times higher than the average household income.  What is just as striking is the degree to which high ratios have become widespread across the top 100 markets.  Even at the previous peak in 2005 - 2006, only 40 to 50 percent of metro areas had a ratio of 4 or above.  In 2024, that share has ballooned to 75 percent.  Similarly, in ‘05/’06 a quarter of the metro areas had a ratio of 3 or below, but that share is now down to less than 5 percent.

The Wall Street View of Affordability

We often think of housing as a very local, very personal thing.  Our friendly realtor helps us find the perfect home, our friendly loan officer helps us navigate the purchase process, and our friends and family help us move in.  The reality, however, is that housing is big business, one which is complicated, heavily regulated and impersonal.  The housing industry as a whole accounts for 16 to 18 percent of the nation’s gross domestic product in a typical year, and any industry that big is going to attract a lot of attention from Wall Street bankers and financiers. 

In many ways, the financial side of the industry is the tail that wags the housing dog, but it is a world which most people don’t understand and its impact on housing affordability is often underappreciated.  To get an understanding of where we are, it is helpful to look back at where we started and to track the key changes along the way.

For much of the 1800s, a personal loan to buy a house was relatively rare.  The required down payment was often more than 50 percent, the term was relatively short (5 to 8 years), and payments were mostly interest followed by a balloon payment at the end for the remaining balance.  Consequently, most loans were made to wealthy individuals, most housing was built incrementally (not in big subdivisions), and most people were renters not owners.

In the last decades of the 1800s, a new form of financing known as a building and loan association became popular.  This was typically a small, local, self-help approach to home ownership.  Associations were formed by a group of local investors who paid an initial fee and subscribed to purchase a certain number of shares (typically less than 10, each with a value of just a few hundred dollars).  They made monthly payments toward the purchase of those shares at a rate which often took 15 years or more to pay off.  Members could apply for loans to purchase or build a home using their shares as collateral.  Profits from interest on the loans were returned to the members as a dividend.  Fully paying off the shares would effectively cancel the loan.

This approach significantly improved access to home financing for the average worker and became so popular that there were more than 12,000 building and loan associations by 1927.  Unfortunately, the Great Depression hit the associations hard and many of them folded which meant that the members lost the value they had accumulated by buying shares.  The role of the building and loan associations was gradually taken over by a new, federally chartered institution known as a Savings & Loan Association (S&L).  In exchange for complying with federal regulations, S&Ls could borrow money from the Federal Home Loan Bank Board and their deposits were guaranteed by the Federal Savings and Loan Insurance Corporation.  

At the same time, the Home Owners’ Loan Corporation was formed to buy delinquent mortgages and refinance them with longer terms and lower interest rates.  These actions (and others) stabilized the mortgage market and lessened the rate of foreclosures, but ushered in an era of federal involvement in the housing finance arena.  The rise of S&Ls (and rule changes that made it easier for commercial banks to issue mortgages) meant that loans were no longer managed by groups of neighborhoods banding together for mutual aid, but rather by the owners and investors of financial institutions.

In 1938, the Federal National Mortgage Association (commonly known as Fannie Mae) was formed with the express purpose of greatly expanding the secondary mortgage market and providing federal money to local banks to finance home loans.  Fannie Mae operated by buying mortgages from local financial institutions, bundling them together into mortgage backed securities (MBS), and then selling those securities to investors around the world.  The net effect was to expand the pool of money available for mortgage loans and to relieve local banks from having to carry long-term mortgages on their books.  

Banks could hold onto loans if they wished, but would generally sell the loans to Fannie Mae and use the proceeds to issue more mortgages.  Banks made money by charging fees for their role in the loan origination process and by earning a portion of the interest rate spread between what they charged borrowers and what they received when selling the loan.  Fannie Mae makes money from the spread between what they buy the loans for and what they sell the mortgage backed securities for.  They also charge fees for guaranteeing the prompt payment of principal and interest on the mortgages that underlie the securities.

The securitization of mortgages has become an enormous market and Fannie Mae is one of the world’s largest corporations based on asset value.  The mix of government organizations and financial institutions that comprise the secondary mortgage market have undergone a variety of changes since 1938, some good and some bad.  But the bottom line is this:  Fannie Mae has provided liquidity to the mortgage market through both good economic times and bad, which has been a huge benefit to the housing industry.  It has also removed much of the risk from local mortgage originators and has standardized the mortgage application and approval process.  On top of all of that, it has probably lowered interest rates to at least some degree.  All of these are good things.

There is, however, a dark side to all of this.  While the ultimate investor makes money from the interest on the mortgage, all of the other players – the banks, the S&Ls, Fannie Mae (and the various spin-offs), and the Wall Street financiers involved in the MBS process – make their money from fees and from the spread on each transaction.  They value volume more than anything else.  So when they say “we want to make homebuying more affordable” what they really mean is “we want more people to qualify for a mortgage so that our volume remains high.” 

That is the motivation behind “innovations” such as the adjustable rate mortgage, low down payment requirements, private mortgage insurance, or reduced qualification requirements for veterans or low-income households.  All of these actions have been touted as making housing more affordable, but that is not what most people mean when they think of affordability.  None of these things lower the actual price of the home being purchased to any great degree – if anything, they make prices go up by stimulating demand.

In fact, one could argue that Wall Street financiers and the leaders of Fannie Mae (et al) don’t really want housing prices to fall.  A significant period of declining home prices would be great news for middle class households who feel priced out of the market, but it would have two side effects that the MBS industry would hate:

• Mortgage delinquency rates and foreclosures would rise, particularly among mortgage holders with low down payments, and rising delinquencies make selling mortgage backed securities more difficult.  This isn’t likely to be serious enough to trigger a financial crisis, but it could easily put a crimp in profits.

• Falling home prices almost always lead to falling housing starts which would reduce the volume of MBS business – another hit to profits. 

Hypocritical But Not Alone

It is easy to call out bankers and the securities industry as being hypocritical.  Expanding access to the mortgage process does benefit their business (and their annual bonuses) but it also benefits people who are on the margins of qualifying for homeownership.  So their behavior isn’t terrible, it just isn’t very helpful at solving the real problem of home prices being out of whack with income levels.

Mortgage bankers might be somewhat hypocritical but they certainly aren’t alone.  Charles Marohn, the founder of the Strong Towns movement, put together this list of who benefits from rising home prices and who doesn’t: [4]

Benefits Doesn’t Benefit

Local government Renters

State government The poor

Federal government

Existing homeowners

Banks & insurance companies

Developers & contractors

Land speculators

Realtors

Pension funds

To be clear, I am on the “benefits” side of the list as an existing homeowner so by all rights I should be working against housing affordability.  The point that I think Marohn is making is that there are a lot of people and organizations who might say they want housing to be more affordable but which might be engaging in the type of double-talk that the mortgage securities industry has been accused of.  No wonder the problem has been so difficult to solve.

The reality is that if we really want to solve the mismatch between housing price and income then a lot of people are going to feel some pain.  Not catastrophic pain, but enough to be uncomfortable.  My house, which has appreciated in value nicely over the past decade or two, might actually fall in value.  The property tax revenue stream which for many cities has been on an upward trajectory due to rising home prices might flatten for several years.  Developers who bought land on the urban fringe thinking that they could build expensive houses and sell them at a lucrative price might have to put their plans on hold.  I think the long term result of falling home prices would be beneficial for our society but I’m not sure that we are public-spirited enough to actually follow through.

The Bottom Line

Over the past 15 years, there has been a widening gap between household income (which has risen slowly) and the price of housing (which has risen rapidly).  Most of the stories in the press focus on the cost of buying a home even though the cost issues affect rental housing as well.  I have argued against the notion that owning your home is an essential part of the American dream (see Post 51), but the belief seems to be as strong as ever.  Still, there is an undeniable logic to the idea that a middle class household with stable employment and a decent paycheck should be able to afford a median priced home.  The fact that they can’t in most metro areas is the source of considerable dissatisfaction and angst.

What is particularly frustrating is that most of the trend lines are moving in the wrong direction despite all the talk about solving the affordability dilemma.  Doing more of what we have been doing appears to be simply making the hole we are in deeper.

You would think that politicians at all levels of government would be scrambling like crazy to solve this problem and, in fact, most of them claim to be working diligently on the problem.  Donald Trump even proposed opening up federal land for the building of up to 10 “Freedom Cities” the size of Washington, D.C. to increase housing supply and bring prices down.  No progress seems to have been made on implementing this idea, perhaps because there is little evidence that a lack of land at the national level is the key issue that needs to be addressed.

Predictably, the proposals which have gained traction – expanding credit score options, reducing the impact of student loan debt, or allowing cryptocurrency to be considered a household asset – are all oriented toward expanding the pool of potential mortgage applicants rather than lowering the actual cost of housing.  In short, don’t count on the Federal government (or Wall Street) to solve this problem.  Instead, I believe we need to combine some out-of-the-box thinking with some hard choices on priorities to really shift the way we produce housing.  Do I have all the answers?  No, but I have some ideas that might move us in the right direction.  Check back next month for the second part of this discussion.

Notes:

1. Elizabeth Yost; “Kansas City homebuyers now need six figures to afford a house”; August 2025; Kansas City Business Journal; https://www.bizjournals.com/kansascity/news/2025/08/15/kc-buyers-income-to-afford-a-home-2025.html

2. Diana Olick; “Nearly one-third of major U.S. housing markets now see falling home prices”; July 2025; CNBC; https://www.bizjournals.com/kansascity/news/2025/08/15/kc-buyers-income-to-afford-a-home-2025.html

3. “The State of the Nation’s Housing 2025”; Joint Center for Housing Studies, Harvard University; https://www.jchs.harvard.edu/sites/default/files/reports/files/Harvard_JCHS_The_State_of_the_Nations_Housing_2025.pdf

4. Charles Marohn; “Who Benefits From Lower Housing Prices?"  April 2019; Strong Towns; https://www.strongtowns.org/journal/2019/4/9/who-benefits-from-lower-housing-prices

Post 59: Zombies and Doom Loops

 Perhaps I should have waited until late October to write this article because it certainly sounds from the title like the content is going to be about scary costumes or horror movies.  My topic, unfortunately, has nothing to do with the entertainment industry or collecting candy door-to-door.  Instead, I’m going to be writing about the dysfunctional office market and its impact on investors, developers and cities.  This is a much less exciting topic, but it is one that should be important to city planners and people concerned about the health of cities generally.  The slow-motion collapse of the office market isn’t going to cause a new financial crisis, but it is likely to cause a significant number of people to lose a significant amount of money and it will crimp the tax revenue stream for a significant number of cities.

Just how bad is it?  According to Cushman and Wakefield, national vacancy rates have risen from 15.2 percent in Q1 of 2021 to 20.8 percent in Q2 of 2025.  National office space absorption rates have been negative for the past 12 quarters, and new office space construction has dropped from 53 million square feet in 2021 to just 6 million square feet for the first half of 2025. [1]

There are four primary reasons for the current office market weakness:  

Leasing retrenchment.  Ten years ago, many white collar employers were hiring almost as fast as they could and leasing (or building) office space in crazy amounts.  The pendulum is now swinging back the other way as employers realize that they have both more people and more office space than they need.  White collar layoffs are increasingly common and the focus is no longer on raw growth, but on growth through efficiency (more with less).  Office space needs are shrinking accordingly.

Work from home.  The impact of the COVID pandemic on remote work has been well documented and as companies realized that they needed fewer workers in the office they also realized that they needed less office space.  Many assumed that as the pandemic waned, workers would return to their offices en masse, but that has not been the case despite several high profile companies demanding that workers return to the office full time.  In fact, a recent Working Arrangements and Attitudes survey found that employer plans and employee desires for remote work averaged 2.3  and 2.9 days per week respectively. [2]  While the difference between what employers and employees want is interesting, the real story in my opinion is that both numbers are well above 2 days per week which means that the push to be back in the office full time is the exception not the rule.

This result is consistent with Kastle System’s 10-city office occupancy barometer based on actual employee access card swipe data.  Their barometer shows occupancy levels between 50 and 60 percent on average (compared with over 90 percent before the pandemic). [3]  Although employee occupancy levels have inched up over the past couple of years, they show no signs of going back to pre-pandemic levels.  Hybrid work schedules are very popular with employees and most employers are willing to accommodate those desires to at least some degree.  Consequently, companies are revamping their office space to be more flexible and they are reducing total space requirements.

Artificial intelligence and off-shoring.  These two unrelated trends both serve to reduce the white collar head count in U.S. offices.  Artificial intelligence, in particular, is a new enough trend that it is hard to predict its eventual impact, but I think it is indicative of the growth-through-efficiency push mentioned above which limits both hiring and office space expansion.  The range of tasks given to AI systems or to workers in India, Mexico or eastern Europe has steadily grown over the past few years and shows no sign of slowing down.  While I don’t think that mass layoffs are likely in the near term, there has certainly been a chilling effect on total employment and on the hiring of entry level workers in this country. 

The declining importance of proximity.  There are undoubtedly still a lot of face-to-face client meetings, sales pitches, power lunches and professional meet-ups but the number is a fraction of what it used to be 20 years ago.  Back then, it was crucial for many businesses to be physically near their clients, supporting businesses and even their competition.  But now, virtual meetings are common and often preferred because they take less time.  Social media of various forms can connect people with common interests far more efficiently than meeting after work for drinks.  Business data can be shared in milliseconds electronically which means that bankers and auditors no longer have to visit in person to “go over the books.”  Finally, globalization means that key decision makers may be spread across states, countries or continents instead of housed at a headquarters building, which makes arranging a face-to-face meeting difficult even if such a thing would be useful.  In short, the forces which used to tightly cluster office uses into dense downtowns or edge-city office parks are dramatically weaker.

The net result has been a reduction in office space demand and a subsequent surplus in office space supply, particularly in areas with historically high office concentrations.  This has not played out, however, in a uniform, everyone-feels-a-little-pain kind of way.  There have been distinct losers in the office market which have led to the addition of “zombies” and “doom loops” to the real estate vocabulary.  These two phenomena deserve a deeper examination to understand their impact on our society, economy and the urban form.

To illustrate what is happening with the office market, I am going to use St Louis as my primary example, although I will include other examples as well.  This is not because St Louis is in terrible economic shape.  It is, in fact, a growing metro area that is thriving in several respects.  While it is not exactly booming, the metro population is up 1.5% over the past three years.  The metro GDP is growing, job growth is strong, and unemployment is lower than the national average.  Per capita personal income has grown by 33 percent over the past five years according to the Bureau of Economic Analysis. [4]  

St Louis does have its challenges, however, and they tend to focus on the urban core represented by St Louis City.  There the population has been in a long, slow decline and poverty has been a particularly acute problem that has been difficult to remedy.

Zombie Buildings

An office zombie is a building that is almost dead, but not quite.  Normally the business world is pretty ruthless in dealing with failure, but for some reason office buildings are often allowed to hang around in zombie status for years while desperate owners, investors and mortgage bankers try to bring it back to life.  A building typically earns zombie status by being at least 50 percent vacant.  Often the owners cannot lease the space at a rent level which would be profitable because demand is so low that market rent levels have plummeted.  This leads to fights between investors and mortgage holders over what limited revenue exists.  This, in turn, makes it almost impossible to get agreement over any plan to reinvest in the property to improve its appeal to potential tenants.  

Owners cling to the hope that the market will bounce back while bankers “extend and pretend” rather than put mortgages into default.  Eventually reality sets in and the true value of the building drops precipitously.  At that point a new buyer might emerge to snap up the building at a bargain basement price with a plan to reuse the building for some other purpose that now makes sense given the new valuation.  But it is hard for the original owners to accept multi-million dollar losses, so the zombie phase can last for quite some time.

St Louis provides two excellent examples of zombie buildings – so good, in fact, that perhaps they should be classed as “super zombies.”   The first is the One AT&T Center (or 909 Chestnut) which is a 44-story office building containing approximately 1.4 million square feet of floor area.  AT&T moved its employees out roughly 12 years ago and the structure has been largely unleased and vacant for the past 8 years.  The building, which reportedly sold for $205 million in 2006, changed hands again last year for just $3.6 million – an astounding  98 percent drop in value. [5]  The new owner is apparently considering converting the building to residential use.

The second example is the Railway Exchange Building, a 22-story structure containing roughly 1.2 million square feet of floor area located just 4 blocks from the AT&T Center.  The bottom seven floors of the century-old building were once home to the flagship location of the Famous-Barr department store.  The upper 15 stories were used as office space, including the headquarters of the Famous-Barr parent company (May Department Stores).  The department store went through a variety of identities and renovations, but eventually closed for good in 2013.  Office tenants soon fled the building as well and it has been entirely vacant for the past 10 years.  A city-financed appraisal of the building returned a value of $5.3 million and the city offered to purchase the property for that amount.  The owner, who had purchased the building in 2017 for $20 million and invested another $30 million for initial renovation work, rejected the offer. [6]

These two examples are particularly mind-boggling because of the enormous loss in value, but they are not all that unusual.  Virtually every major office market has similar zombie buildings.  Two years ago, CBRE estimated that 7 percent of all office buildings were less than 50 percent leased. [7]  Given recent market trends, that number has probably not improved since then.  What is perhaps more concerning is that there is a relatively large number of office buildings that are between 50 percent and 80 percent leased – or what we might call “zombie adjacent.”  A building that is only two-thirds leased is not in good financial shape and runs the risk of spiraling into zombie territory if things go the wrong way. This is particularly true for large buildings with over 300,000 square feet of space.  For those buildings, roughly 30 percent fall into the zombie adjacent zone.  If the market recovers soon, most of them will likely survive but if not then the list of zombie buildings could grow rapidly.

So who is losing money when an office building becomes a zombie?  The answer is a lot of people all around the world.  Many office projects are financed through Commercial Mortgage Backed Securities (or CMBS) which are then sold to investors, pension funds, banks, insurance companies, real estate investment trusts (REITs), and on and on.  CMBS delinquency rates have skyrocketed from less than 2 percent in 2023 to over 10 percent currently, matching the previous high that occurred following the financial crisis (2012 - 2013).  Since the CMBS process tends to spread the risk pretty widely, zombie office buildings aren’t likely to trigger an economic meltdown, but they are likely to cause a fair number of business bankruptcies in the real estate development world and in the small businesses (e.g. restaurants, bars, dry cleaners, hair salons, etc.) that used to thrive on the employees that worked in those buildings.  In addition, zombie offices act as a drag on urban growth, holding back local economies that otherwise might be prospering.

The flip side of this story is that many office buildings are doing just fine.  The ones that are doing the best tend to be relatively new buildings that have invested in tenant amenities. In the push to get workers back in the office, there has been a “flight to quality” as companies have either moved to nicer buildings or convinced their landlords to make significant building improvements.  Among the top five in-demand amenities are nearby public transit and easy access to parking – underscoring the conclusion that simplifying commutes is high on employee wish lists if their bosses are going to insist on a return-to-work policy.  

Older, class B or C buildings which have not kept up are the most likely zombie candidates, but class A buildings are not immune.  Factors that are out of the control of building owners may be the final straw that pushes a building into zombie status.  A huge, 1.7 million square foot office zombie in the River North neighborhood of Chicago is dragging down the surrounding area and putting other office buildings at risk.  Office utilization in River North is 48 percent of its 2019 level, well below Chicago and national averages. [8]  One obvious failure can taint an entire district.

In Portland, the precipitating factors likely included the city’s accommodating approach to homelessness and the State’s experiment with drug decriminalization.  U.S. Bancorp Tower, a 42-story office building that is now more than 50 percent vacant, is a case in point.  When Digital Trends, a major tenant, moved out recently they filed a lease termination lawsuit that included charges of vagrants sleeping in hallways, starting fires, smoking fentanyl, and defecating in common areas.  The building is reportedly up for sale with an asking price in the neighborhood of $70 million – approximately 80 percent below what the owners paid for it a decade ago. [9]

Urban Doom Loops

A zombie office building is bad, but a cluster of zombie buildings is much worse.  The fear is that multiple zombie buildings could produce a self-reinforcing downward spiral for an entire downtown or office district.  The theory goes as follows:

• High vacancy rates in multiple buildings causes the number of employees in the area to drop substantially compared with previous times when buildings were full;

• The drop in office foot traffic causes nearby retail uses (restaurants, bars, hair salons, dry cleaners, etc.) to go out of business and makes it less likely that the remaining office workers will hang around the area after work;

• Property taxes and sales taxes collected by the city fall because empty office buildings have much lower valuations and closed retailers have no sales;

• Reduced tax revenue causes budget cuts which force reduced service levels for policing, sanitation, infrastructure repair, and transit frequency;

• Closed storefronts, vacant offices, poor service levels and a limited number of people on the street make the remaining office workers feel unsafe and the area is perceived as being on a downward path – which causes more companies to leave the area which deepens the cycle of decline.

This negative spiral was given the name “urban doom loop” by a team of university business professors from Columbia University and New York University.  To date the urban doom loop has been more theoretical than real since there are no actual examples of office districts that have gone completely down the drain.  There are, however, quite a few cities where office vacancies have soared to levels where the doom loop label is being tossed about.  This includes many markets where office development had boomed in the past such as Seattle, Boston, Atlanta, Portland, San Francisco, and Houston.

St. Louis is perhaps the downtown office district that has gone furthest down the doom loop spiral.  Just over a year ago the Wall Street Journal did a profile of the downtown area titled “The Real Estate Nightmare Unfolding in Downtown St. Louis.”  According to the article the St. Louis central business district had the biggest drop in foot traffic of 66 major North American cities between the start of the pandemic and the summer of 2023.  The Journal article focused on a 15-block area where it claimed there were two closed storefronts for every open one. [10]  Foot traffic and leasing activity have bounced back somewhat since that time, but the perception of failure and danger still linger.

A recently released study of downtown St. Louis cited the statistic that 25 office buildings in the area are at least 25 percent vacant and that 10 of those buildings – all within a quarter-mile radius – account for 76 percent of all downtown vacancy.  In inflation-adjusted terms, average office rents have declined by 14 percent between 2019 and 2024.  Similarly, office leasing activity in downtown St. Louis has declined from an average of 616,000 square feet per year (2014 through 2019) to just 152,000 square feet in 2024. [11]  The depressed office market has convinced several building owners to convert from offices to residential units.  Three such projects have been completed since 2020, three more are in the planning stage, and there is the potential for several more.

Lessons Learned

Fortunately, doom loops are typically interrupted at some point when building values have fallen so far that a new round of investors are willing to take over failed buildings and either convert them to some other use or substantially remodel them so that they can compete in the office market.  The problem is that one rescued building is not likely to be enough to turn around an office district in the midst of a doom loop spiral.  Multiple investor groups have to rescue multiple buildings at more or less the same time so that the public perception changes from a place of failure and danger to one of exciting new possibilities.  

It takes a lot of work to make that shift happen and there is a decent chance that the rescue effort will also fail.  Consequently, investors will be interested only if the potential payback is very lucrative – which means that the buildings they are buying have to be dirt cheap.  That only happens when the original owners have given up all hope of coming out unscathed.

From the perspective of cities, the zombie/doom loop phenomenon is another lesson in urban dynamics.   I think there are at least three things that cities should learn from what is currently happening:

• Success is fragile and complacency must be avoided at all costs.  Twenty or thirty years ago the office market was booming and downtowns and office parks were being filled with gleaming office towers.  City leaders and office developers couldn’t pat each other on the back hard enough and every rock turned out to be gold.  Success made us blind to the changes in technology which made remote work roughly as productive as being in the office and to the productivity increases that made many white collar jobs superfluous.  Too few people were thinking about what would come after the office boom, they just wanted to get one more office tower built.

• Single-use districts are generally a mistake.  When the office market was booming, no one wanted to build anything other than office buildings.  You couldn’t hardly pay developers to build residential buildings when building an office building was a virtual printing press for money.  Unfortunately, the city planning profession was complicit in this mistake by devising zoning rules which made building mixed-use districts difficult.  We turned large chunks of our urban core from interesting, self-sufficient urban hearts into sterile containers for workers.  We ignored all the other things that cities should do in order to focus on one thing.  Healthy cities are a constantly shifting mix of uses and structures, not a monoculture.

• Buildings need to be adaptable.  Any structure which is built reasonably well will last a long time.  In many cases, longer than its original use will last, which means that it may need to be adapted to some other use or be torn down.  While tearing a building down is not a disaster, re-using a building is almost always more economically efficient.  The problem is that building adaptable buildings is more expensive and if no one is placing value on adaptability, then such an expense seems like a waste of money.  This often seems to play out most clearly in smaller cities where the economy cannot tolerate waste.  It is common to see houses get converted to small business locations, or vacant supermarkets get converted to churches or medical clinics.  Every structure gets re-used until it physically falls apart.  That lesson was lost during the office boom when buildings were so optimized for office uses that they are now difficult (i.e. expensive) to adapt to anything else.  Yes, some office buildings are being converted to residential apartments but that tends to work only for an older office building that pre-dated the boom (and was built in a more adaptable way), or when the value of a newer building has plummeted to almost nothing.

I would like to say that the office market is rapidly improving and the issues caused by zombie buildings will soon be gone, but alas that is not the case.  There are signs of improvement and in some areas new office construction has picked up a little steam.  The economy is expanding and employees are gradually adapting to being back in the office.  Consequently, many office buildings that are currently on the edge of the abyss will likely survive.

Unfortunately, that is not universally true.  In fact, the national office vacancy rate might well creep a percentage point or two higher before it stabilizes and eventually declines.  There is still an enormous amount of vacant space – more space, in my opinion, than is likely to be absorbed by normal office demand growth in the next five to ten years.  That means that a lot of current office floor area needs to be removed from the market through either conversion to other uses or by being torn down.  And by a lot I mean hundreds of millions of square feet.

The most promising path to the goal of floor area removal is through the conversion of office buildings to residential apartments or condominiums, because it not only removes office space from the market but it also increases the supply of residential units to areas that are frequently undersupplied.  That can be a win-win scenario for downtowns that desperately need more people on the street for the perception of safety and more disposable income in the pockets of people who might support downtown restaurants, shops and other businesses.

It is not, however, an easy path to follow.  To begin with, there is a lot of expense involved with turning office space into residential space.  The plumbing and HVAC needs are completely different and it is often difficult to retrofit modern office buildings for residential units.  In addition, the resulting rentable floor area and the rent-per-square-foot is often lower by a significant amount.  Finally, no one wants to live in an area that is deserted outside the hours of 8 AM to 5 PM which means that multiple projects need to be happening at the same time to convince potential residents to take a chance on living in a converted property.  The bottom line is that only some buildings are good candidates for conversion and the economics of the project will only make sense if the value of the building drops substantially from what it was worth during its office heyday. 

For better or worse, there are going to be a lot of conversion candidates to consider.  Hundreds of billions in office debt will need to be refinanced in the next couple of years.  High interest rates and falling office valuations are going to make that difficult, so building owners may be looking for alternatives.  In the midwest, several cities are leading the way.  Chicago, Cleveland, Cincinnati, Minneapolis and Kansas City have all been active in conversions.  That trend needs to spread to other cities and the pace of conversions needs to stay high if the doom loop spiral is to be avoided.  I am cautiously optimistic but we are not out of the woods yet.

Notes:

1. “U.S. Office Reports - Q2 2025”; Cushman & Wakefield; July 2025; https://www.cushmanwakefield.com/en/united-states/insights/us-marketbeats/us-office-marketbeat-reports#:~:text=Only%202.3%20msf%20of%20new%20office%20space,four%20markets%20have%20over%201.5%25%20of%20inventory

 

2. Edward Pierzak; “Office REITS: High Quality Properties Attract and Retain Tenants, Outpace Peers”; January 2025; Nareit; https://www.reit.com/news/articles/office-reits-high-quality-properties-attract--retain-tenants-outpace-peers

3. “Getting American Back to Work”; Kastle Systems; July 2025; https://www.kastle.com/safety-wellness/getting-america-back-to-work/#workplace-barometer

4. “New GDP Numbers Show St Louis’ Economic Momentum Continues”; December 2024; Greater St Louis, Inc.; https://greaterstlinc.com/news/press-release/new-gdp-numbers-show-st-louis-economic-momentum-continues#:~:text=The%20data%2C%20released%20by%20the,income%20divided%20by%20its%20population.

5. Mark Heschmeyer; “One of St. Louis’ Tallest Office Towers, Empty for Years, Sells for Less Than 2% of Its Peak Price”; April 2024; CoStar News; https://www.costar.com/article/642008108/one-of-st-louis-tallest-office-towers-empty-for-years-sells-for-less-than-2-of-its-peak-price

6. Stephen Davis; “St. Louis should be leery of eminent domain as a solution to downtown’s ‘doom loop’ “; July 2025; Pacific Legal Foundation; https://pacificlegal.org/st-louis-should-be-leery-of-eminent-domain-as-a-solution-to-downtowns-doom-loop/

7. “Most US Office Buildings More Than 90 Percent Leased”; August 2023; CBRE Insights; https://www.cbre.com/insights/briefs/most-us-office-buildings-more-than-90-percent-leased

8. Matt Wirz; “The ‘Zombie Buildings’ at the Heart of the Office Meltdown”; April 2025; The Wall Street Journal; https://www.wsj.com/real-estate/commercial/chicago-office-buildings-real-estate-market-1913fe3a?mod=Searchresults_pos2&page=1

9. Peter Grant; “A Fire Sale of Portland’s Largest Office Tower Shows How Far the City Has Fallen”; May 2025; The Wall Street Journal; https://www.wsj.com/real-estate/commercial/a-fire-sale-of-portlands-largest-office-tower-shows-how-far-the-city-has-fallen-322e0f2d

10. Konrad Putzier; “The Real Estate Nightmare Unfolding in Downtown St. Louis”; April 2024; The Wall Street Journal; https://www.wsj.com/real-estate/commercial/doom-loop-st-louis-44505465?mod=Searchresults_pos2&page=1

11. Mary Elizabeth Campbell, et al.; “Reversing an ‘urban doom loop’ in St. Louis through office-to-residential conversion”; March 2025; Brookings; https://www.brookings.edu/articles/reversing-an-urban-doom-loop-in-st-louis-through-office-to-residential-conversion/#:~:text=Annual%20average%20leasing%20activity%20has,2019%20numbers%20(Table%2011).