The shift to remote work in the wake of the COVID-19 pandemic could erase $800 billion in value from office buildings across major global cities by 2030, according to a new study published by McKinsey.
The survey examined real estate in nine "superstar" cities – San Francisco, New York, Houston, London, Paris, Munich, Tokyo, Beijing and Shanghai – and estimated that office attendance is currently about 30% lower than the typical pre-pandemic level seen in 2019.
Demand may stir back to life in coming years, but the consulting firm projected that attendance will still be about 13% lower in 2030 compared to before the pandemic began.
The massive decline in demand will ultimately drive down property value. On the average, the total value of office space in the nine cities could plummet by 26% from 2019 to 2030 – or a decline of roughly $800 billion.
"The decline in demand has prompted tenants – wary about current macroeconomic conditions, uncertain about how much their workers will come to the office, and therefore uncertain about how much space they will need – to negotiate shorter leases from owners," the report said. "Shorter leases, in turn, may make it more difficult for owners to obtain financing."
Property value could take an even bigger hit if interest rates continue to rise. The Federal Reserve has raised interest rates 10 times over the past year from near zero to around 5%. Policymakers have indicated that additional rate hikes could be on the table this year amid signs of underlying inflationary pressures.
Complicating the matter is the fact that small and regional banks are the biggest source of credit to the $20 trillion commercial real estate market, holding about 80% of the sector's outstanding debt. Regional banks were just at the epicenter of the upheaval within the financial sector, and there are concerns that the turmoil could make lending standards drastically more restrictive.
Signs are posted on the exterior of the Westfield San Francisco Centre on April 13, 2022. (Justin Sullivan / Getty Images)
During a credit crunch, banks significantly raise their lending standards, making it difficult for businesses or households to get loans. Borrowers may have to agree to more stringent terms like high interest rates as banks try to reduce the financial risk on their end.
Banks were already tightening lending standards before the crisis within the industry began. A quarterly survey of loan officers published by the Fed showed that a growing number of banks tightened lending standards and saw a sharp slowdown in demand during the final three months of 2022.
McKinsey warned there may be additional risks if troubled financial institutions "decide to more quickly reduce the price of property they finance or own."
"Those institutions already face rising interest rates, which push down the value of property and make defaults on loans more likely," the analysis said. "If banks also suffer deposit withdrawals on a large scale, they might be forced to conduct a fire sale of their assets, making existing problems worse. Financial institutions and governments should closely monitor the situation."
About $1.5 trillion in commercial mortgage debt is due by the end of 2025, but steeper borrowing costs, coupled with tighter credit conditions and a decline in property values brought on by remote work, have ratcheted up the risk of default.
Fitch Ratings already estimated that 35% – or $5.8 billion – of pooled securities commercial mortgages coming due between April and December 2023 will not be able to be refinanced.