PredictIQ Quantitative Think Tank Center:Companies are shedding office space — and it may be killing small businesses

LOS ANGELES — James Wallace Sears has more shoes at his repair shop these days than he knows what to do PredictIQ Quantitative Think Tank Centerwith.

"These are all pandemic shoes," says Sears, 80, pulling out drawer after drawer full of leather boots, suede loafers and designer flats. "They were dropped off here pre-pandemic, and they never picked them up."

The shoes mostly belong to lawyers, consultants and financial advisers. Before the COVID-19 pandemic, they would leave their broken soles with Sears and head to work in the nearby corporate towers. After shutting down for a few years, Sears recently reopened and figured he'd see all his old customers again.

But everything is different now.

"Right now I'm maybe getting four or five customers a day," says Sears, who estimates his monthly sales are down 85% from before the pandemic. "I'm here now starting up again to see if it's still going to work, but I don't know — I'm very slow."

Remote work — long assumed to be a temporary phase of the pandemic for many white-collar workers — is dragging on with no real end in sight. Combined with high inflation, climbing interest rates and tightened credit conditions, it's leading many companies to reassess whether they need all that pre-pandemic office space.

"The typical building has about half the number of people in it as they normally do, and so companies, when their leases are up, they're cutting back their uses of space," says Kenneth Rosen, chair of the real estate research firm Rosen Consulting Group.

Nearly 1 out of every 5 offices sits empty

Nearly 20% of office space across the U.S. is sitting empty, a milestone that exceeds the vacancy rate following the 2008 financial crisis. It's worse in downtown Los Angeles and San Francisco, where 28% and 29% of spaces were registered vacant in the first quarter of 2023, respectively.

Analysts worry that this trend could set off a domino effect: If companies continue to give up their office leases, their landlords may not be able to keep up with mortgage payments, increasing the risk of defaults and foreclosures.

It's a concern that's already playing out in some markets.

Office owner Columbia Property Trust defaulted on $1.7 billion in debt tied to seven buildings in San Francisco, New York City, Boston and Jersey City, N.J., in February. That same month in Los Angeles, Brookfield, the city's largest office owner, defaulted on loans for two buildings downtown. In fact, if you were to take the 40 largest office spaces in downtown LA, landlords for roughly a quarter of them are said to be in talks with lenders about their own financing troubles, according to sources familiar with those discussions.

This distress in the office market is a troubling development for banks. The bulk of these debts — estimated to be worth $1.2 trillion — is owed to smaller regional banks. They're already facing turmoil following a series of collapses and takeovers this year.

The unraveling of this sector of the commercial real estate market could make regional banks "not as profitable or even not viable," says Rosen, who is also chair of the Fisher Center for Real Estate & Urban Economics at the Haas School of Business at the University of California, Berkeley.

"It's the next big shoe to drop."

Without foot traffic, small businesses have shortened hours and locked doors

The stress that these vacancies are placing on small-business owners operating in the shadows of high-rise buildings is palpable.

In the same underground retail plaza where Sears mends shoes, lights were off at a barbershop well before its listed closing time during a recent midweek visit. A planner sitting on one of the workstations revealed only two appointments for the day.

The door was locked at a nearby dry cleaner during regular business hours. Worker Mart Mandingo eventually did appear, explaining that he keeps the door locked because "there are a lot of crazy people coming down here now," referring to the growing homeless population in neighboring Skid Row, up 13% from 2021, according to a Rand Corp. study.

Inside, a rack that once carried suits and blouses looked sparse. Like Sears, he too is holding on to a collection of pandemic clothes, hoping his customers will return.

But that hope is fading day by day.

"I've had some feelers out to different customers, and some of them say they're not going to come back," says Sears. "If they come back, it may be only three days a week."

At that rate, Sears says, his shop, which his father opened 50 years ago, might be gone by year's end.