International Finance

Will remote work hurt office economy?

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The worst-case scenario for workplaces depends on the continuation of high levels of remote work arrangements

The office has provided a long-term substitute for the manual labour that characterised work for most of human history. However, it has caused a unique set of challenges for employees.

The majority of offices closed during the good part of the 2020 COVID pandemic. Over 60% of all paid full-day workdays were completed remotely. Jump forward to 2024, employees are hesitant to return. Although it has decreased from its peak in 2020, the percentage of remote work is still quite high at 28%, or over six times that of the pre-pandemic period.

According to a 2023 working paper published by the National Bureau of Economic Research (NBER), employees who worked from home saved an average of 72 minutes every day by avoiding commuting. Many firms offered remote work options in the tight labour market that followed the first lockdown period to draw in a bigger pool of employment seekers.

Many people are concerned about the future of workplaces due to the prevalence of hybrid work. Some businesses have determined that they require less space than they did before the pandemic since employees are visiting less frequently.

Market observers are trying to forecast where the next crisis might arise and are now concentrating on what this shrinkage means for the commercial real estate (CRE) industry as well as the larger financial system.

Assessing workplace demand

During the pandemic, office security company Kastle started releasing weekly office occupancy statistics based on information from the 2,600 properties it manages. Office occupancy in its top 10 metro areas is about 50%; it is lower on Mondays and Fridays and higher in the middle of the week. The national director of office analytics for CoStar Group, Phil Mobley, reports that a record high of 12.9% of office space is unoccupied.

The CRE technology platform VTS generates a monthly office demand index. The release of COVID-19 vaccinations appeared to be likely to lead to a strong comeback to the office in 2021, which caused the VTS Office Demand Index to spike briefly. However, such hopes were dashed when the delta variant emerged. It has been locked far below its pre-pandemic value since the middle of 2022.

Another measure of the demand for offices in the market is provided by publicly traded office real estate investment trusts or REITs. This is the FTSE National Association of Real Estate Investment Trusts (NAREIT) for the United States. The Real Estate Index Series monitors the US Properties by kind of REIT. Its office index dropped by 15.9% at the end of March 2023, after falling by 37.6% in 2022. Because of their higher demand, offices owned by publicly traded REITs are sometimes seen as leading indicators for the industry.

Arpit Gupta from New York University, Vrinda Mittal and Stijn Van Nieuwerburgh from Columbia University, and others estimated the impact of the pandemic on offices using data from the NAREIT office index and CompStak, a data platform for CRE brokers, in a working paper from September 2022.

To determine the availability and demand for remote employment, they also examined job listings on Ladders, a job search engine that specialises in positions paying more than $100,000 annually. They calculated that a company’s need for office space drops by roughly 4 to 5% points for every 10% increase in the percentage of remote job ads.

However, not all office buildings are seeing such a dramatic decline in demand. Gupta, Mittal, and Van Nieuwerburgh conducted a thorough analysis of the data and discovered that over the previous three years, the highest-class buildings (A+ properties) outperformed others. In a similar vein, the office demand picture presented in a recent report by CRE company Cushman & Wakefield is more nuanced than the sum totals would indicate. In the paper “Obsolescence Equals Opportunity,” it is stated that the market share of office buildings with above 50% vacancy is only 7.5%. Demand for recently constructed, superior office buildings increased throughout the pandemic.

Nevertheless, the authors predict that over the next ten years, there will be 1.1 billion square feet of surplus office space as production outpaces demand. But they only credit the increase in remote work for only 30% of that surplus supply. The remaining amount is the outcome of normal fluctuations in supply and demand as certain buildings age out of the market and businesses modify their space requirements in response to evolving business circumstances.

“Work from home will still have an impact, but it’s not the main factor influencing behaviour at the moment,” says Rebecca Rockey, Cushman & Wakefield’s global head of economic analysis and forecasting, while elaborating, “We’re now coming into what we think is more of a business-cycle driven downturn. Some of the recent weakening in the office market has been tied to the tech sector, which was very aggressive in leasing markets during the pandemic. Now they are scaling back. We are also seeing businesses attempting to cut costs in what is widely viewed as the most well-anticipated recession ever.”

In early 2023, San Francisco-based software corporation Salesforce revealed plans to downsize office space in select locations and lay off 10% of its workers (and they are still firing their staffers). Facebook’s parent company, Meta, also announced in 2024 about cutting jobs and reducing the amount of space it occupies in San Francisco by 435,000 square feet. Additionally, Amazon said in March 2023 that it would stop building its second headquarters in Arlington, Virginia.

Demand for office space has historically increased in direct proportion to employment growth in office positions. That link collapsed during the COVID recovery, as the labour market recovered quickly but the return to the workplace happened more gradually.

The Cushman & Wakefield experts predict that after businesses decide on a combination of in-person and remote work, this connection will stabilise. However, going forward, it is likely that less space will be required for each employee than it was before the pandemic.

Which shoe will drop next?

There are signs of an excess of office space shortly, regardless of whether businesses are reducing their requirement for office space as a result of remote work or declining economic conditions.

The law of supply and demand indicates that office building values will decline as a result of this. Gupta, Mittal, and Van Nieuwerburgh projected that by the end of the decade, the office building sector will lose 39% of its value in comparison to 2019 after simulating different scenarios for the continuation of remote work. But offices have other challenges than a lacklustre demand. All long-term investments, including real estate, lose value as interest rates rise.

Refinancing debt becomes more expensive when interest rates rise. Office buildings are usually funded using a combination of debt and equity, just like residential dwellings. Since the average office mortgage lasts for ten years, many of the loans that are about to mature were taken out at a time when interest rates were significantly lower. Simultaneously, a decline in office tenant demand may make it more difficult for landlords to pay off their debt by decreasing rental income. This has raised fears that the financial system may be facing catastrophic consequences in the form of a wave of defaults.

CRE mortgages come from a range of sources and include loans for offices as well as retail, multifamily housing, and other commercial property types.

According to a report by Rich Hill, head of real estate strategy and research for asset management firm Cohen & Steers, banks and thrifts have the greatest proportion, almost 45%.

When construction loans are taken out of the equation, the percentage drops to less than 40%. About 13% of all CRE loans, including loans for building and income-producing properties, are held by the top 25 banks, while their exposure is relatively low (less than 4% of total assets). About 32% of all CRE mortgages are held by regional and community banks outside of the top 25, and these loans typically make up a far larger portion of their assets.

Following Silicon Valley Bank and Signature Bank’s bankruptcies in March 2023, the banking industry has come under increased scrutiny. CRE loans did contribute to previous banking crises, even though neither of the above failures appears to have been caused by CRE lending.

Research from the Richmond Fed indicates that from 2008 to 2012, banks that had a large percentage of CRE loans were approximately three times as likely to fail as banks throughout the country. Furthermore, banks that extended high-risk loans during the 1980s CRE development boom were more likely to collapse when the decade’s property prices crashed.

The bank’s delinquency rate on CRE loans is still far below 1%, much lower than what was seen during the last two crises. Many observers anticipate that number to increase as more loans become due, but commercial lending requirements are also more stringent now than they were before the 2007–2008 financial crisis.

Compared to the normal residential mortgage, office mortgages often have loan-to-values between 50% and 60%, which indicates the proportion of debt financing to the property value. Office loans account for just 3% of the assets of regional and community banks and less than 17% of the total CRE mortgage market, according to Cohen & Steers’ Hill estimate.

“Commercial real estate assets all have different fundamentals,” Hill states, stating further, “While the office is under pressure, other sectors are doing quite well right now.”

Office buildings that were last financed in 2013 may very well have increased in value even after taking into consideration the recent drop since office mortgages typically have a ten-year term. This implies that a borrower’s equity would not be destroyed by current losses unless they were very significant.

Positive aspects

The worst-case scenario for workplaces depends on the continuation of high levels of remote work arrangements. The model by Gupta, Mittal, and Van Nieuwerburgh includes scenarios in which office valuations recover and the economy returns to a more limited degree of remote labour. Even the most upbeat office champions don’t think that in-person employment will return to its pre-pandemic proportions, but employers’ willingness to accept remote labour is beginning to wane.

Some firms are recognising that remote workers in other nations may be able to complete jobs that Americans can do entirely from home for less money, especially when the labour market softens in some industries. Some have begun to raise the amount of days that staff members are required to physically show up to work. Walt Disney is requesting that employees report to work four days a week, and senior management at JPMorgan Chase was recently informed that they will have to work five days a week. Additionally, some firms, like the New York-based legal firm Davis Polk & Wardwell LLP, have threatened to reduce bonus payments to staff members who disregard in-person responsibilities.

Following Silicon Valley Bank’s failure, the Financial Times’ Tabby Kinder and Antoine Gara revealed that the majority of the 8,500 workers of the bank were working remotely. The absence of coincidental “water cooler” chats might have played a role in the bank’s inability to identify its issues.

Nicholas Bloom, an economist at Stanford University who has been studying remote work since before the pandemic, informed Kinder and Gara that “ideas like hedging interest rate risk often come up over lunch or in small meetings.”

“I think we’re definitely going to see more of a return to the office, but the way companies and employees want to use the office has changed,” Hill says.

Office owners have other options besides giving up the keys when demand declines. Renovating the area with contemporary facilities and adaptable workspaces intended for a hybrid workforce may be sufficient to win back tenants, depending on the fundamental qualities of the property.

“In terms of reimagining their buildings, adding desired amenities and technology, and creating collaborative areas within the common spaces of the buildings, commercial property owners in Rosslyn have been incredibly innovative,” says Mary-Claire Burick, president of the Rosslyn Business Improvement District, a 17-block mixed-use area in downtown Rosslyn, Virginia, which is located just outside of Washington, D.C.

Some even suggested in the early stages of the COVID that vacant offices might be turned into homes, to help address the chronic lack of affordable housing. It turns out that this is far from simple. Plumbing and window location, for example, are two areas where the standard apartment and office building layouts diverge significantly. Zoning would frequently also need to be altered to permit residential buildings inside commercial offices. Finally, before such a conversion became financially appealing, the price of an office building would need to plummet dramatically because most commercial assets are substantially more expensive than multifamily dwellings.

However, this kind of reuse is feasible, especially with local legislators’ backing. New York City authorities implemented a tax incentive programme to promote the conversion of abandoned Manhattan offices into residential units during the office market collapse of the early 1990s. Between 1995 and 2006, the initiative resulted in the conversion of about 13 million square feet of office space or around 13% of the lower Manhattan market. As a result, around 13,000 new housing units were built, which makes up more than 40% of the increase in lower Manhattan housing between 1990 and 2020. The programme was especially successful in promoting the conversion of older office stock that was constructed before 1945.

Even while offices will encounter many difficulties in the upcoming years, there don’t now seem to be many hazards to the industry as a whole or to bank lenders in particular. Bank authorities; however, appear to be closely monitoring these trends in light of previous crises in which real estate played a significant role. In a speech to the Institute of International Bankers on March 6, Chairman of the FDIC Martin Gruenberg stated that office headwinds’ impact on bank balance sheets was “an area of ongoing supervisory attention.”

“When it comes to managing the fallout, we want to make sure that banks are as well-capitalised as possible,” Van Nieuwerburgh states, while concluding, “One thing we learnt from the subprime crisis is that you don’t want to force all your banks to foreclose on nonperforming loans too quickly. But you also don’t want to make the opposite mistake of extending loans that will never be performing. You want to thread a middle ground.”

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