Core business centers in cities across the US are experiencing significant downturns in office space usage due to the rise of hybrid and remote work policies during the COVID-19 pandemic. McKinsey & Company, a global management consulting firm, reports that office space use has decreased by 20% to 40%.
At the onset of the pandemic in March 2020, downtown areas were left largely empty as companies shifted to remote work. However, there has been a slow return to the office, with average occupancy reaching 50% of pre-pandemic levels in March 2021, according to CBRE Group, a commercial real estate services firm. Despite this increase, the decline in office space value and the need to redefine the concept of an office remain pressing issues.
The impact of the pandemic on office values is evident in cities like San Francisco and New York City. An office building worth $300 million in San Francisco before the pandemic may now only be valued at $60 million, representing an 80% loss. In New York City, office values declined by 45% in 2020 and continued to drop by 39% over the next two years, resulting in a loss of $453 billion in overall office real estate value, as stated in a study by the National Bureau of Economic Research.
Even smaller cities, such as Durham, NC, are not immune to the challenges facing commercial areas. The headquarters of health information technology firm IQVIA in Durham remains vacant due to hybrid and remote work policies. The Research Triangle, which encompasses Raleigh, Durham, and Chapel Hill, currently has a record high of 4.4 million square feet of vacant office space, accounting for 8.3% of the overall market inventory.
As the shift to hybrid and remote work becomes a long-term trend, the future of traditional downtown offices and its implications for workers become uncertain. Ryan Luby, an associate partner at the McKinsey Global Institute think tank, emphasizes that hybrid work has been widely adopted during the pandemic and is likely to persist even during an economic recession.
Some reports attribute the increase in office vacancies to high-profile layoffs, particularly in the technology sector. However, the labor market remains tight. The pandemic unintentionally revealed that remote work is preferred by many employees and that knowledge workers can be just as productive, if not more so, when working from home. It also highlighted that working in an office environment may not be equally beneficial to all individuals, leading to a higher demand for workplace flexibility.
Micah Remley, CEO of workplace management software maker Robin Powered, acknowledges that companies face a communication challenge in implementing hybrid work policies. He emphasizes the importance of clarifying what hybrid work means for each organization and obtaining employee buy-in, rather than forcing employees back to the office with the threat of pay cuts.
The widespread adoption of hybrid work has resulted in a structural shift in the office market, leading to a decrease in demand for office space. CBRE’s report reveals that the overall vacancy rate reached a 30-year high of 17.3% in the last quarter of 2022. Kastle Systems, a provider of fob security key technology, also confirms that average daily office attendance has remained around 50% of pre-pandemic rates.
Interestingly, CBRE finds that just 10% of US office buildings account for 80% of the vacancy created since 2020, despite representing only 17% of the total office square footage. Downtown buildings are particularly affected, with 41% classified as the hardest hit buildings (HHBs), compared to 29% nationally. Crime rates and the absence of surrounding amenities, such as restaurants and retail stores, are factors contributing to high vacancy rates in these areas.
Even as some companies push for a return to the office, CBRE reports negative net absorption of 16.5 million square feet in the first quarter of 2023, the lowest demand for office space in two years. Recession fears and the prevalence of hybrid work arrangements are cited as reasons for this decline.
Even before the pandemic, office space was often underutilized, with studies showing that up to 30% to 40% of office space remained unused. Phil Kirschner, an associate partner at McKinsey & Co., highlights the discrepancy between leased office space and actual office utilization, revealing a need for a reevaluation of space requirements.
CBRE estimates that if no action is taken to address the impact of hybrid work on existing buildings, the long-term US structural vacancy rate could rise from 12% to 14.5%, resulting in an additional 103 million square feet of vacant space. This poses challenges for building owners, banks, leasing tenants, and potentially even taxpayers, in the case of government bailouts.
A shift towards flexibility and hybrid work is reshaping the commercial real estate market. Without conviction that a full return to pre-pandemic office culture is imminent, the effects on the industry will continue to be evident. A thorough reassessment of office spaces, their value, and their purpose is necessary to adapt to this new era of work.
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