Subject Matter Expert: Ruth Colp-Haber, CRE
While other areas of commercial real estate have recovered from the dramatic effects of the pandemic, office is continuing to battle fundamental changes in how and where people choose to work that have weakened overall demand for space. According to CBRE Econometric Advisors, the overall U.S. vacancy rate is expected to peak at 19.7% by the end of 2024.
We’ve been waiting for work from home to abate, whether that’s workers choosing to return or employers insisting people come back. Yet there has been little progress over the past two years. In New York City, for example, the attendance rate is approximately 50%.
Structural shifts in workplace behavior have big ripple effects for office owners, lenders, and investors, as well as the health of central business districts (CBDs). Urban centers have long relied on office buildings for their contributions to the tax base and a daytime office population that drives a bigger real estate ecosystem and CBD experience.
Seismic ripple effects
The office sector faces big questions that will continue to play out over the next five years. What’s going to happen to these empty buildings? What’s going to happen to the debt on these buildings? What’s going to happen to the cities that have diminished tax revenue?
Challenges are not the same everywhere. But when one goes to a CBD in a major metro such as New York, San Francisco, Chicago, or Philadelphia, the impact on the landlords is evident. Lower occupancies mean lower NOI and lower valuations. Capital for office properties has dried up, and even for those that can find financing, capital is more expensive, and owners need to put in more equity. Many of the office buildings that are facing the biggest occupancy challenges need updating and renovations, which will require even more capital.
CBD office is at the core of a city’s economy, and many cities are beginning to fear the effects of depressed CBDs. In some cases, property values have dropped by as much as 50% or more. It takes time for lower values to work through the appraisal and tax appeal process before it starts impacting city finances. But we shall see the impact over the next decade.
Time for creative thinking
All of these big cities need more affordable housing, but converting office space into housing is not an easy thing. It’s expensive, it’s time-consuming. Sometimes it doesn’t make sense, and the more practical solution is to demolish the office rather than converting the existing structure to a new use. The successful cities will reinvent themselves, and we’re starting to see that in New York. The areas of the economy that need help, such as residential, healthcare, and education, are emerging as users for parts of these commercial buildings.
The decline of urban centers is not a new phenomenon. Cities have seen cycles of decline where there has been an exodus from downtowns to the suburbs for various reasons, such as crime and a better cost of living. Once again, now is the time to dig in and be creative and imaginative in strengthening CBDs, which is going to involve a more diversified mix of uses and repurposing of empty office buildings. Solutions also will require more collaboration between the industry and public and private community leaders.
