Workers continue to resist a return to the office, triggering a potentially seismic shift in commercial real estate demand.
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The shift to remote work is killing demand for office space and setting up a potential meltdown in the commercial real estate market over the next decade.

The average office occupancy across 10 major U.S. cities tracked by Kastle System was at about 47% at the end of September, less than half what it was pre-pandemic and just a marginal increase from the 36% occupancy rate U.S. offices were seeing a year ago, when many believed a significant return to the workplace was imminent. The number of workers returning to the office appears to have plateaued and, in some cities, office occupancy rates have barely budged from where they were at the end of 2021, when the omicron wave of the coronavirus upended many companies' return-to-office plans.

Companies are shrinking their footprints, leaving older, dated spaces and driving up vacancy rates in major cities as American workers continue to resist calls to return to the office. The absence of downtown workers has become a crisis for cities that rely on full offices for property tax revenues and patronage of shops and restaurants, and the problem will likely worsen as lengthy lease agreements begin to end.

"This is not just a temporary shock due to the pandemic," said Howard Chernick, an economics professor at Hunter College. "This is a long-term adjustment."

Workers also want to be even more remote than they are now. A survey from the second quarter of 2022 by 451 Research found that 82% of employees want to work at least some of the week remotely, including more than 27% who wanted to be entirely remote.

Many of the workers returning to offices are doing so only on a part-time basis. That will keep demand for office space lower post-pandemic, said Gus Faucher, chief economist at PNC Financial Services Group.

"Some businesses are trying to push back against this, but workers have more bargaining power now than they did and businesses that try to force workers back into the office full-time will find themselves at a disadvantage," Faucher said.

New York impact

New York City will be among the hardest hit as plummeting demand for office space destroys $453.6 billion in commercial real estate value in coming years, according to a new working paper from New York and Columbia universities. The decline could be even worse if workers choose to stay home at similar or higher rates than they are now.

"There is a 'worse case' scenario in which remote work sticks around for even longer than expected," said Arpit Gupta, a finance professor at NYU's Stern School of Business and one of the paper's co-authors, in an email.

A recent survey of 160 major Manhattan office employers found that while only 16% of office workers are fully remote, just 9% are in the office five days per week. By January 2023, 12% of workers will be fully remote, but only 11% will be in the office full-time, according to the survey from the Partnership for New York City.

The U.S. office vacancy rate was 17.6% in the second quarter of 2022, while the vacancy rate was 21.6% in downtown Manhattan, according to Cushman & Wakefield, a commercial real estate services company. Prior to the pandemic, the national vacancy rate was 13.5% and downtown Manhattan was 11.4%.

The shift to remote work has drawn concern from big city mayors and business leaders. New York City Mayor Eric Adams has been an outspoken critic of remote work, saying that the city's economy is being drained by a lack of office workers.

'Fiscal doom loop'

Office assets are typically financed with debt, which remains on bank balance sheets and in commercial mortgage-backed securities portfolios. That means substantial declines in commercial real estate value would severely harm institutional investors and overall financial stability. Property taxes from commercial offices and adjacent retail spaces would plunge, affecting local government revenues.

"A decline in office and adjacent retail real estate valuations may activate a fiscal doom loop that lowers the quality of life for residents and worsens the business environment," the NYU and Columbia paper states.

Still, rental rates continue to rise, with the national average rising to $37.03 per square foot in the second quarter, up 9% from pre-pandemic rates, according to Cushman & Wakefield.

Some investors continue to prosper. Office real estate investment trusts, or REITs, which make up only a small fraction of the U.S. commercial real estate market, have not seen a significant decline in occupancy rates. And rental rates for office REITs are on the rise, climbing to $50.30 per square foot in the second quarter, up 10% from pre-pandemic rates, according to S&P Global Market Intelligence data.

Those figures signal that companies are moving to higher-end properties, which have been more successful than older, lower-end units at leasing out the majority of their space. Companies may be moving to smaller, nicer offices as part of efforts to reduce their footprints while luring workers in with more attractive workspaces.

"By contrast, lower quality office stock appears to be a more substantially stranded asset, given lower demand, raising questions about whether these assets will ultimately need to be repurposed towards other uses," the Columbia and NYU paper states.

This trend may not truly flourish until later this decade as many commercial office leases expire. More than 60% of current U.S. office REIT leases will not expire until after 2027, according to Market Intelligence data.

Big cities hit

As those leases expire, rental prices will decline and cities could be devastated, said Chernick with Hunter College: "The question then becomes: What happens to cities?"

The answer to that question will differ depending on city size.

Chernick recently co-authored a study that found that larger cities are hit more severely since they have a higher concentration of workers in the sectors most likely to work remotely: finance; information; professional, scientific and technical services; and management. Up to 80% of employees who work in these four industries can work from home, Chernick said.

Chernick found that San Francisco was the most vulnerable American city to the economic hit caused by the shift to remote work, followed by New York, Boston and Atlanta.

Smaller cities with fewer of these remote jobs will be less impacted. A commercial real estate crisis may be brewing in San Francisco and New York, but not in Shreveport, Louisiana, or Las Cruces, New Mexico.

A lasting trend

A commercial real estate collapse may be inevitable as the shift to remote working seems to be part of the trend in American labor, from farm to factory, factory to office, and now office to home, said James Bianco, president of Bianco Research.

"Workers need to gather with co-workers, but the current model is no longer working," Bianco said. "The office is going the way of the farm and factory when it comes to Americans' attitudes about work."

Still, the trend could reverse. Office space once leased by tech or finance firms could draw interest from universities or medical centers. In addition, if economic conditions deteriorate further, workers may abandon their plans to continue working from home, Faucher with PNC said.

"A severe recession could lead to a return to the previous balance of power in the labor market, with firms demanding that workers come into the office, and workers complying because they're worried about getting laid off," Faucher said.

451 Research is part of S&P Global Market Intelligence.