The seismic shift in working patterns caused by the COVID-19 pandemic has left the office real estate market grappling with enduring challenges. A recent report by Cushman & Wakefield indicates that there could be up to 1 billion square feet of unused U.S. office space by the end of the decade, nearly 1.5 times the vacancy levels at the pandemic’s outset.
While it took just a couple of years for the office real estate market to hit a decades-low vacancy rate, experts have little confidence in a swift recovery. The office vacancy rate currently stands at nearly 20%, and Stijn Van Nieuwerburgh, a respected European economist and professor of real estate and finance at Columbia Business School, referred to the situation as a “trainwreck in slow motion.”
Van Nieuwerburgh pointed to several factors contributing to the market’s challenges. Firstly, the uncertainty surrounding the renewal of pre-pandemic leases, given their average seven-year duration, may take years to resolve. Many tenants are waiting for leases to expire before making space decisions, impacting landlord cash flows.
As vacancies rise, rents are expected to fall, putting further pressure on the market. Landlords are also facing challenges when refinancing mortgage loans due to elevated interest rates, reduced building values, and cash flow issues stemming from vacancies.
City tax assessments, conducted infrequently, hinder property value determinations. The prospect of a market rebound is contingent on a return to pre-pandemic work patterns and a consensus among companies that the current hybrid work model negatively affects productivity.
In response to the ongoing office market struggles, commercial real estate investors are increasingly exploring property conversions, particularly office-to-residential projects. Converting office spaces into multifamily units may help address the housing shortage. While several projects are underway, the scope for conversions remains significant.
Van Nieuwerburgh cautioned that not all conversion projects are economically viable, emphasizing that only about 10% of office buildings in downtown areas with substantial vacancies may be suitable for repurposing. This trend extends beyond residential use to mixed-use spaces, medical offices, student dorms, childcare facilities, and more.