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Filled Jobs, Empty Offices

Unemployment is down, skilled workers are getting harder to find, companies are seeking technology as ways to improve productivity with fewer staff. And one aspect of modern business has taken a major hit in the last three years: office occupancy. Employees spend far less time working at the office than they did before the pandemic, according to McKinsey Global Institute.

When the COVID-19 pandemic began, it dramatically changed the way people worked, lived, and shopped in cities around the world. The starkest change was where and how they worked. Obeying lockdowns and office closures, tired of uncomfortable masks, and enabled by remote-work technology, many employees abruptly retreated from traditional offices to home offices.

Many of those employees, newly freed from their daily commutes, chose to move out of urban cores. And now that fewer of them were working and living near urban stores, fewer of them shopped there. In recent months, some of those behavioral shifts have slowed. Others persist, particularly among office employees continuing to engage in hybrid work (that is, a combination of remote and in-office work).

The behavioral shifts have already had major effects on real estate in “superstar” cities—roughly speaking, cities with a disproportionate share of the world’s urban GDP (gross domestic product) and GDP growth. In superstar cities’ urban cores, the percentage of office and retail space that is vacant has grown sharply since 2019, and home prices have increased more slowly than in the suburbs and other cities.

My Office, My Home

In early 2020, as they adopted remote work and hybrid work in response to lockdowns and health concerns, office attendance in many metropolitan areas dropped by up to 90%. It has since recovered substantially but remains down by about 30%, on average. As of October 2022, office workers were visiting the office about 3.5 days per week. That number varied among surveyed cities, from 3.1 days in London to 3.9 in Beijing.

Office attendance also varies by industry and neighborhood. In large firms in the knowledge economy—defined as the professional services, information, and finance industries—employees tend to go to the office fewer days per week. Characteristics of areas with lower office attendance include expensive housing, a higher ratio of inbound commuters to residents, and a limited or small retail sector. Local culture also plays a role.

McKinsey says there are several reasons to believe the current rate of office attendance could persist. First, the rate has remained fairly stable since mid-2022. Second, three key numbers—the number of days per week that survey respondents go to the office (3.5), the number of days they expected to go to the office after the pandemic’s end (3.7), and their preferred number (3.2)—are not far apart. Third, 10% of the people surveyed said they were both likely to quit their jobs if required to work at the office every day and willing to take a substantial pay cut if doing so let them work from home when they wanted.

That group contains many senior, high-income employees, suggesting they may wield influence over companies’ decisions. Nevertheless, it is not certain the current rate of office attendance will persist; it could change, for example, if labor market dynamics shift or if research conclusively indicates either a negative or a positive relationship between hybrid work and productivity.

According to a new survey by The Conference Board, 54% of companies are mandating or strongly encouraging workers to be on-site. However, nearly 80% are still working either fully remote or hybrid schedules. In fact, workers’ dissatisfaction with return-to-office mandates may lead more workers to jump ship. Nearly a third of those required to come back to the workplace said their intent to stay with their organization had decreased.

The survey also reveals the pros and cons of fully remote versus fully on-site work. Most strikingly, the results suggest a relationship between companies with fully remote working employees and layoffs: 33% of remote employees report their companies have implemented layoffs, compared to only 13% of fully on-site workers.

Statistically, the workers who went remote during the pandemic have strong feelings about returning to “the old ways.” Still, more than half say they have no concerns about the office environment while 28% are worried about the increased time and cost to commute and 21% are worried about increased interruptions or distractions.

Significantly more men working fully on site say they have no concerns about working in the physical workplace (60%) than women (38%). Women are more concerned about distractions in the office (35% versus 14%), the time and cost of commuting (38% versus 22%), and constant expectations of being available (28% versus 7%).

And there is also a generational difference. About 38% of Millennials working fully on site are concerned about the time and cost of commuting, compared to 27% of Gen Xers and 24% of Baby Boomers. Work/life integration are a concern, as well, with 35% of Millennials working fully on site concerned compared to 20% of Gen Xers and 14% of Baby Boomers. And 31% of Millennials working fully on site are concerned about the constant expectation to be available compared to 14% of Gen Xers and 12% of Baby Boomers.

Leaving Home And City

One of the results of the growing mandates to return to the office is a growing acceptance of moving to another location. Even during the pandemic, McKinsey notes, a number of households left the urban cores of “superstar cities,” and fewer households moved in. For example, New York City’s urban core lost 5% of its population from mid-2020 to mid-2022, San Francisco’s lost 6% during the same period, and London’s lost 7% from mid-2020 to mid-2021. In the suburbs, by contrast, populations grew, or they shrank less dramatically than populations in the urban cores did. In the United States, suburbanization had already been happening before the pandemic, and the shock accelerated an existing trend.

The urban cores where population growth was smallest in relation to their suburbs tended to be those with expensive homes, high office density, a high share of workers in the knowledge economy, and limited retail presence—some of the same characteristics that shaped office attendance. London, Dallas, New York, San Francisco, and Boston were the most affected. In general, U.S. urban cores were more affected than European and Japanese ones, which tend to have more mixed-use development, where office, residential, and retail space exist alongside one another. Out-migration from urban cores of superstar cities seems to have slowed, but it is still above pre-pandemic levels.

Hybrid work seems to have contributed significantly to out-migration. In McKinsey’s survey, among respondents who moved after March 2020, 20% admit their move was possible only because they could now work from home more frequently. In the United States, people who had moved from urban cores to suburbs, and who said that their move was possible only because they could now work from home, said that they were drawn by housing conditions: better neighborhoods, the prospect of homeownership, and outdoor space. In Japan and China, wanting to own a home was far and away the strongest factor motivating people’s moves to the suburbs.

Out-migration from urban cores of superstar cities seems to have slowed, but it is still above pre-pandemic levels. From 2019 to 2021, net out-migration from U.S. superstar city cores doubled; then it fell in 2022, although it remained above 2019 rates. In other words, the people who moved out during the pandemic are not moving back, and others keep leaving.

Trends And Predictions

McKinsey Global Institute modeled future demand for office, residential, and retail space in several situations. Its predictions include that demand for office and retail space will be generally lower in 2030 than it was in 2019, though the anticipated reductions are smaller than those projected by many other researchers. The analysis shows the ripple effects will be complex—for example, certain kinds of cities and neighborhoods will be more heavily affected than others.

The research considered a wide variety of factors, including long-term population trends; employment trends, such as the ongoing effects of automation; office attendance patterns by industry; employee coordination, defined as the maximum share of workers in the office at a given time; workers’ ages and incomes; the share of a city’s population that commutes from elsewhere; housing price variation among neighborhoods; and shopping trends, such as the ongoing increase in online shopping.

Retailers in urban cores face particularly acute challenges in attracting customers. As of October 2022, foot traffic had recovered noticeably less near those stores than near suburban ones. In New York, for example, foot traffic near suburban stores was 16% lower than it had been in January 2020, but foot traffic near urban stores was 36% lower.

And office-dense neighborhoods in urban cores are facing even more challenges. The reason seems to be that when people come to the office less often, they shop less often near the office. In McKinsey’s survey, respondents in the United States who worked at the office no more than one day per week reported doing much less of their total retail spending near the office than did those who worked in the office two to five days a week.

Shopping isn’t the only affected area. Demand for office space has already declined, partly because of the increase in remote work and partly because of a challenging macroeconomic environment. Vacancy rates have increased in all the cities McKinsey studied. In the U.S. cities, transaction volume—the total dollar value of all sales—fell by 57%, average sale price per square foot fell by 20%, and asking rents fell by nearly 22% (all in real terms) from 2019 to 2022.

In San Francisco, the most strongly affected city in the United States, the share of office space that was vacant was ten percentage points higher in 2022 than it was in 2019, transaction volume was 79% lower, sale prices per square foot were 24% lower, and asking rents were 28% lower (also in real terms). 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. Shorter leases, in turn, may make it more difficult for owners to obtain financing or may cause banks to adjust valuation models, which rely in part on the duration of existing leases.

McKinsey predicts the amount of office space demanded in most cities will not return to pre-pandemic levels for decades. By 2030, demand is as much as 20% lower than it was in 2019, depending on the city. And that estimate is a moderate scenario—one in which, by 2025, office attendance is higher than it is now but still lower than it was before the pandemic, and that partial recovery continues indefinitely. 

In a more severe scenario, in which attendance for all office workers in 2030 falls to the rate already seen in large firms in the knowledge economy, demand is as much as 38% lower than it was in 2019, again depending on the city.

Supply, Demand, Vacancy

In the nine cities studied, a total of $800 billion (in real terms) in value is at stake by 2030 in the moderate scenario. On average, the total value of office space declines by 26% from 2019 to 2030 in the moderate scenario and by 42% in the severe one. The impact on value could be even stronger if rising interest rates compound it. Similarly, the impact could be stronger if troubled financial institutions decide to quickly reduce the price of property they finance or own.

Falling demand will also result in a surplus of office space, particularly in the lower-quality and older buildings that the real estate industry calls Class B and Class C. From 2020 to 2022, rents, demand, and sometimes prices generally grew more quickly (or fell less sharply) for Class A buildings than for Class B buildings in U.S. superstar cities. For example, in New York City during that period, the average sale price per square foot rose 3% for Class A buildings but fell by 8% for Class B buildings. 

There are several reasons for this “flight to quality.” One is that many employers see high-quality space as a way to encourage office attendance among their employees. Another is that Class B and Class C office space is often not suited to hybrid work; for example, it may have less sophisticated audiovisual or networking equipment. Now that hybrid work has reduced the total amount of space that employers need, they can spend their budgets on smaller amounts of higher-quality space rather than larger amounts of lower-quality space.

As mentioned, retail areas near offices have taken a hit. Vacancy in retail space has increased and rents have declined, particularly in office-dense locations. As with office and residential space, vacancy rates increased from 2019 to 2022 in all the superstar urban cores, ranging from a 1.8-percentage-point increase in San Francisco to a 6.2-percentage-point increase in London.

Mixing And Matching

One answer might be that cities could adapt through mixed-use neighborhoods—neighborhoods that are not dominated by a single type of real estate (especially offices) but instead incorporate a diverse mix of office, residential, and retail space. Such hybrid neighborhoods were becoming more popular even before the pandemic and now that the pandemic has reduced demand for offices, cities have been left with vacant space that could be converted to other uses.

Redeveloping neighborhoods is an enormous undertaking, of course, so mobilizing the many stakeholders is important. Governments may be particularly helpful in reforming restrictive zoning policies. Investors would be needed to finance redevelopment. And developers would be the ones to turn mixed-use visions into realities.

Suburbs can benefit from change, as well. City dwellers, untethered from their daily commutes and thus less concerned about living far from urban cores, are increasingly seeking larger homes in greener areas. More housing and retail in the suburbs could help satisfy their preferences. More multifamily housing could be particularly beneficial because it would accommodate more people than single-family homes do.

As long as the apartments are larger and more comfortable than apartments in urban cores, they could attract urbanites seeking space. Suburban policy makers could consider encouraging multifamily development by adjusting zoning, offering incentives to developers, and reexamining regulations that prevent housing from being built, such as those governing minimum dwelling sizes and window requirements.

Furthermore, multifamily housing is more energy-efficient than single-family homes, so it could help push down carbon emissions. And because it accommodates many people, it could help alleviate the shortage of housing that many metropolitan areas suffer from, making living in those areas more affordable.

Adaptable And Flexible

To adapt to declining demand for traditional office and retail space, developers could create hybrid buildings. The most ambitious vision is a universal, “neutral-use” building whose design, infrastructure, and technology could be easily modified to serve different uses. Imagine a medical building that could be easily converted into, say, a hotel or an apartment building if customers’ preferences changed. More modestly, buildings could be designed to accommodate different degrees of collaborative and individual work or different arrangements of open and closed offices. They could also include technology that promotes flexibility, such as sensors to track patterns of usage that could inform an employer’s approach to hybrid work.

Hybrid buildings would bring at least two advantages: they would protect owners from shifts in preferences that are impossible to predict now and, because tenants will now be moving in and out more frequently, buildings might become more valuable if they grow more adaptable.

Developers could also try to convert offices into the kinds of space for which there is more demand, such as apartments, hotels, and schools. Obstacles include rezoning, renegotiating existing lease commitments to allow for renovations, and dealing with physical limitations. Furthermore, even if all excess office space were converted into housing, the amount of residential space in each city would grow by less than 3%. Still, for owners facing the prospect of lower occupancy and lower rents in their office buildings, the opportunity cost of conversion has fallen, and the number of successful conversions may grow.

Developers of retail space too could keep adaptability in mind. Lately, retail tenants have been evaluating their footprints with a stricter eye, shutting down stores or moving into smaller spaces. If developers built more adaptable spaces, they would be likelier to remain relevant to tenants’ shifting needs. Developers might also offer new store formats, such as spaces intended for delivery and fulfillment or for logistics rather than traditional retail. Or they might design buildings that are more integrated with their environments—for example, with dining spaces that extend onto sidewalks.

Tenants in urban cores—both the employers who rent office space and the merchants who rent retail space—may have to start “earning the commute” from office workers and shoppers who would otherwise visit less often. Here too, thinking flexibly and adaptably can help. For example, the office does not have to be just a place to work; it can also be a place where employees genuinely enjoy spending time or where they can take part in compelling events and activities. Office tenants might try to attract them by building magnetic, hospitality-oriented workplaces or design more modular spaces that can adapt to changes in work patterns from week to week. And the most forward-thinking tenants will provide an efficient, digital way to organize hybrid work patterns and preferences.

Turning empty spaces into hybrid places could be a way to transform cities and prepare them for a dynamic, prosperous future. Indeed, it is not hard to imagine more “hybrid floors” in which offices, residences, and stores exist side by side. For floors—as for buildings and neighborhoods—turning empty spaces into hybrid places may not simply be a way to counter the damage wrought by the pandemic, it could be a way to transform companies and cities and prepare them for the future.

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