While some regions of the U.S. are growing, office space in major cities sits empty.

As borrowing expenses surge and downtown offices remain deserted, even major corporations are realizing their miscalculations. The COVID-19 pandemic catalyzed a “seismic shift” in commercial real estate, enabled by technology, as millions of people were compelled to work remotely for the first time.

Seven trophy buildings, including a San Francisco tower leased to Elon Musk’s Twitter, were subject to approximately $1.7 billion worth of mortgage defaults by Columbia Property Trust. However, this company was not the only one to default; Brookfield Corp., one of the world’s largest property owners, also defaulted on two Los Angeles skyscrapers, with one of them being named after accounting firm Deloitte.

Recent loan defaults are part of a strategy to extend payment periods or negotiate improved loan terms. However, in some instances, building owners are surrendering their properties to lenders, indicating that they have given up on ownership.

Regardless of the approach, these actions suggest a gloomy outlook for the overall market. When even well-funded money managers hesitate to purchase properties with premium tenants in prime areas, it raises concerns about the fate of owners with older, less occupied buildings and limited financial resources.

In the last 10 years, investors viewed office buildings as if they were bonds. They considered high-quality structures with long-term leases and continuously increasing rents as extremely secure investments. Companies like Amazon and Facebook were investing in expensive urban locations, equipping them with features such as plant walls and espresso machines.

Although office buildings are not impervious to economic fluctuations, even the largest money managers failed to anticipate the rapid impact of remote work on thousands of offices. The ambiguity surrounding the future of work has transformed office space from a long-term, fixed asset to an increasingly hazardous and unpredictable one.

Similar to how e-commerce hastened the decline of outdated suburban malls, remote work will lead to the downfall of business districts. According to one brokerage, there will be approximately 330 million square feet of surplus office space by the conclusion of this decade. Empty offices leave many pondering whether remote work has directly affected the commercial real estate market in many major cities.

 

Is Remote Work Affecting the Office Space Market?

Despite many employers adopting hybrid work schedules, business districts are still only receiving less than half of the pre-pandemic office workers consistently.

The most significant issue is in America’s largest cities. According to Kastle Systems, which monitors how many employees swipe into office buildings daily, national office usage reached a pandemic-era peak of 44% in early June. However, major cities like Philadelphia, Chicago, San Francisco, and New York have lagged behind in returning to offices.

Presently, the average office usage is approximately 50% of pre-pandemic levels, which may become the new standard. The market does not seem to anticipate a resurgence. The stock prices of New York’s largest office real estate investment trust, Vornado Realty Trust, have declined to levels last seen in 1997, whereas those of SL Green Realty and Boston Properties are currently below their 2020 lows.

Due to the nearly nonexistent interest rates, the majority of landlords were able to maintain their buildings without defaulting on their loans during the pandemic, making it easier for them to continue making payments or acquire new financing. Similar to Pimco’s Murray, investors remained optimistic that more individuals would return to their offices once pandemic anxieties diminished. Nonetheless, some landlords may not be able to maintain their properties long enough to witness such an occurrence.

The Mortgage Bankers Association indicates that nearly $92 billion of nonbank office debt is maturing this year and requires refinancing. Banks, which are the primary source of commercial real estate financing, are avoiding office loans after being cautioned by regulators last year about over-exposure. Office building values have already declined by 25% in comparison to just a year ago, according to real estate analytics firm Green Street.

The economic outlook is bleaker in 2023, with the Federal Reserve predicting an increase in the unemployment rate to 4.6% by the end of the year. Even with economic recovery, it’s evident that many office buildings won’t bounce back. Owners are considering converting offices to housing, but this won’t have a significant impact on office supply in the short term due to zoning regulations, high costs, and engineering complexities.

Low occupancy is hurting many landlords, but how are big companies with traditional large office space portfolios handling the downturn?

 

Big Tech Companies in Major Cities Reduce Office Space

Construction of Amazon’s second headquarters near Washington has been paused, while Facebook’s parent company, Meta Platforms Inc., has reduced its leased space in New York. Twitter Inc. is also in dispute with Columbia Property over rent for its San Francisco building and has recently offered most of its New York headquarters for sublease.

Google has announced its downsizing plans by implementing Cloud Office Evolution (CLOE), where employees and partners of its cloud division will share desks across the five major locations, including San Francisco and New York.

During Alphabet’s fourth-quarter earnings call in early February, executives disclosed that they anticipate Google to bear costs of approximately $500 million in the current period due to reduced worldwide office space, as the company confronts slowing revenue growth and persisting concerns about the recession. 

During the call, Google CEO Sundar Pichai said that many employees are only coming into the office two days a week, resulting in an inefficient use of the available space.

“We should be good stewards of financial resources,” Pichai said. “We have expensive real estate. And if they’re only utilized 30% of the time, we have to be careful in how we think about it.” 

Big companies in major cities are starting to offload office buildings and leases, but some regions of the U.S. are seeing commercial real estate growth and some companies are expanding their office space.

 

Commercial Real Estate in Some U.S. Regions Continues to Thrive

Although many commercial real estate landlords are facing low occupancy rates, there is a gradual increase in the number of workers returning to the office. 

Occupancy rates in U.S. offices have increased, surpassing 50% for the first time since the COVID-19 pandemic began. Kastle reported that all 10 of the major cities it tracks have surpassed 40% for the first time. 

McKinsey reports that a majority of Americans, specifically 87%, prefer a flexible working environment that enables them to work both in an office and virtually. Meanwhile, a recent survey by Slack revealed that just 12% of individuals would opt to work in the office on a full-time basis.

Research—including research published by Worldwide ERC in 2022—has found that many business leaders want to bring employees back to the office. Interestingly, office occupancy has fluctuated. It reached over 50.4% in late January, dropped to 45.6% in early February, and has since recovered slightly to 48.6%.

The impact of the pandemic on commercial real estate investment varies from city to city. Despite losing the headquarters of major corporations like Boeing, Citadel, and Caterpillar to other cities, Chicago has maintained its position as the top city for commercial real estate investment for the 10th consecutive year.

According to the National Association of Industrial and Office Parks’ annual study, Texas accounted for 20% of the nation’s commercial real estate spending last year, with commercial construction projects totaling $70 billion. The Dallas Morning News reported these figures.

Organizations that have a lower number of employees returning to full-time in-office work are potentially reconsidering their office space plans. However, for businesses enthusiastic about returning to the office full-time, this presents an opportunity to secure office leases at lower rates than usual.