US: Get ready for a big downturn — America's 'office apocalypse' is even worse than expected

© Marianne Ayala/Insider Remote work is gutting downtowns, forcing leaders to reinvent the postpandemic city. Marianne Ayala/Insider

Deserted downtowns have been haunting US cities since the beginning of the pandemic.

Before the pandemic, 95% of offices were occupied. Today that number is closer to 47%. Employees' not returning to downtown offices has had a domino effect: Less foot traffic, less public-transit use, and more shuttered businesses have caused many downtowns to feel more like ghost towns. Even 2 1/2 years later, most city downtowns aren't back to where they were prepandemic.

Not unlike how deindustrialization led to abandoned factories and warehouses, the pandemic has led downtowns into a new period of transition. In the 1920s factories were replaced by gleaming commercial high-rises occupied by white-collar workers, but it's not clear yet what today's empty skyscrapers will become. What is clear is that an office-centric downtown is soon to be a thing of the past. With demand for housing in cities skyrocketing, the most obvious next step would be to turn empty offices into apartments and condos. But the push to convert underutilized office space into housing has been sluggish.

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Without more-robust policies to address failing downtowns, cities are going to start hurting. Even small declines in foot traffic and real-estate use compounding over time will lead to reduced tax revenue and sales receipts for small businesses, ultimately affecting city budgets. And while city planners are reimagining downtowns, the impact on cities' bottom lines has been devastating; in New York, for instance, the value of commercial real estate declined by 45% in 2020, and research suggests it will remain 39% below prepandemic levels.

Less economic activity in urban cores and a lower tax base could mean fewer jobs and reduced government services, perpetuating a vicious cycle that further reduces foot traffic in downtowns, leading to more decline, more crime, and a lower quality of life. For residents of many downtowns, ghost downtowns will be a visible infliction, and throngs of people crowding into a bus on a Monday morning will be apparitions of a recent past.

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The death of great American downtowns

The devastation of downtown commercial districts has been an unmistakable shift in America's largest cities. In San Francisco, the landmark Salesforce tower and other buildings have remained mostly unoccupied as the tech industry has embraced remote and hybrid work. In New York, Meta recently terminated its lease agreement for three offices totaling 450,000 square feet in Hudson Yards and on Park Avenue, taking a significant financial hit. This tracks with trends: San Francisco has faced office-vacancy rates of 34% to 40% in some parts of the city, while in New York about 50% of workers are back in the office.

Even in cities where more workers have returned, like Austin or Dallas, occupancy rates are still only 60% of what they were prepandemic. These shifts follow the unassailable stickiness of remote work; researchers for the National Bureau of Economic Research predicted that 30% of workdays would be worked from home by the end of this year, a huge jump from before the pandemic.

The increased cancellations of office leases have cratered the office real-estate market. A study led by Arpit Gupta, a professor of finance at New York University's Stern School of Business, characterized the value wipeout as an "apocalypse." It estimated that $453 billion in real-estate value would be lost across US cities, with a 17-percentage-point decline in lease revenue from January 2020 to May 2022. The shock to real-estate valuations has been sharp: One building in San Francisco's Mission District that sold for $397 million in 2019 is on the market for about $155 million, a 60% decline.

Other key indicators that economists use to measure the economic vitality of downtowns include office vacancy rates, public-transportation ridership, and local business spending. Across the country, public-transportation ridership remains stuck at about 70% of prepandemic levels. If only 56% of employees of financial firms in New York are in the office on a given day, the health of a city's urban core is negatively affected.

The second-order effects of remote work and a real-estate apocalypse are still playing out, but it isn't looking good. Declines in real-estate valuations lead to lower property taxes, which affects the revenue collected to foot the bill of city budgets. Declines in foot traffic have deteriorated business corridors; a recent survey by the National League of Cities suggested cities expect at least a 2.5% decline in sales-tax receipts and a 4% decline in revenue for fiscal 2022. Last year, Atlanta's tax revenue was projected to decline by 5.7%. Finding and retaining government employees has been a problem in New York, where public-sector salaries haven't kept up with inflation. Day-to-day operations and essential government services such as public transportation, trash collection, and street cleaning would undoubtedly take a hit from hamstrung city budgets.

It comes as no surprise, then, that in recent months the combination of a stagnant flow of tax receipts and hollowed-out downtowns has spooked city leaders. At a recent conference, the mayor of Seattle, Bruce Harrell, expressed concern about tax revenue. "The fact of the matter is there will never be the good ol' days where everyone's downtown working," he said. London Breed, San Francisco's mayor, told Bloomberg that "life as we knew it before the pandemic is not going to go back." In the National League of Cities' 2022 survey, almost a third of cities said they'd be in a difficult financial situation in 2023 once federal funds dissipate. In the event of a recession, things could look much worse.

It's about new housing, stupid

While there's been a lack of demand for commercial real estate, the residential market has gone into overdrive. A recent NBER paper suggests the new space requirements of remote workers — space for a desk or office, or to accommodate the extra time spent at home — have helped cause housing costs to skyrocket.

The solution to the office-housing conundrum seems obvious: Turn commercial spaces like offices into housing. Empty offices can become apartments to ease housing pressure while also bringing more people back to downtown areas. But after two years, few buildings have been converted. Jessica Morin, the head of US office research at the commercial real-estate firm Coldwell Banker Richard Ellis, said there hasn't been a "noticeable increase" in conversions. Since 2016, only 112 commercial office spaces in the US have been converted, while 85 projects are underway or have been announced, according to CBRE's data. Despite the promise of new housing –– one recent study in Los Angeles estimated that 72,000 new homes could be built in the city by converting offices and hotels –– progress has been slow.

So what's going on? Simply: The costs to convert are often hard for developers to justify. Construction costs are assessed on a building-by-building basis and need to take into account structural issues such as floor layouts, plumbing, and window access. Residential buildings also have to accommodate shared spaces like hallways, meaning they generally have less rentable space than an office building. Rising costs of labor and increasing interest rates may dampen efforts to convert offices to homes and inject more risk for developers. "The cost of construction is just so high, and even if you set aside the specific issues related to conversions and just think about the economics of building anything, it's just gotten very difficult," Gupta told me.

Another barrier for office-to-residential conversions is local housing rules. To turn commercial buildings into housing, they would have to be rezoned — which requires input from community members and local officials — to meet specific requirements. Codes for everything from lighting to sustainability vary by city, presenting irregular hurdles in project costs and timelines. Housing developers may not want to put themselves in precarious political situations or go through resource-draining approval processes for a high-risk project with potentially significant financial downside.

Gupta's study suggested, however, that continually falling office values may kick off more interest from developers in adaptive-reuse projects. Despite their cost and complexity, they may be better than letting a building sit empty.

The birth of the central social district

To avoid a commercial real-estate apocalypse, cities will need to streamline conversions. There are several ways to do this. California has set aside $400 million for adaptive-reuse-incentive grants. New York state approved a $100 million fund for hotel conversions, but the stringent requirements led to only a single developer applicant.

Most impactful on the city level would be land-use planning processes that could help speed up conversions. Laws like the Adaptive Reuse Ordinance that Los Angeles passed in 1999 could help dispense with some of the more onerous city-code hurdles, like parking requirements. Gupta suggested that cities could also adapt their tax codes to make conversions more economically feasible by moving to a land-value tax or something similar. Federal initiatives could provide tax credits to developers to ensure buildings are readapted and could provide support for city planners to assist with redevelopment projects.

Overall, combating the death of downtowns requires a reworking of how we think about cities and the value they provide. The urban author Jane Jacobs proclaimed in her famous 1958 article for Fortune magazine, "Downtown Is for People," that "there is no logic that can be superimposed on the city; people make it, and it is to them, not buildings, that we must fit our plans."

While the central business district characterized downtowns in the 20th century, the latest revitalization of cities will hinge on social value. Remote work has isolated people, and central social districts can be the new lure for cities. Restaurants, coffee shops, and coworking spaces are becoming just as important as industry hubs for a city's economy. The urbanist Richard Florida argued in an article for Bloomberg in August that for cities to survive postpandemic, they must transform into places for robust social connectivity. Dense downtowns in Austin and New York have seen steep increases in rental demand, a sign that people continue to be willing to pay a premium to live in a social district.

The transformation is likely to mean mixed-use 24-hour neighborhoods and downtowns where nearly all daily necessities are within walking or cycling distance of where people live. In Montréal and New York, some open-street programs developed during the pandemic became permanent, allowing people and events to replace moving vehicles year-round or during the summer months. The repurposing of rail yards in Sante Fe, New Mexico, and of elevated train lines in New York into parks shows that adaptive reuse can be applied to park infrastructure as well.

The corporatization of work led to urbanization, but the trend today is a decorporatization of downtowns. Out of previous financial districts, new vibrant neighborhoods could form and reestablish local consumption. It would require infrastructure upgrades and the adaptation of public spaces and streets, but, as Gupta noted, office buildings are already ideally situated "smack-dab in the center of the transit network." Meanwhile, research has linked mixed-use areas with lower crime rates than commercial districts.

The economic health of cities is intrinsically linked to how space is used or unused, and right now downtowns are undergoing a massive shift. Despite the sluggish movement, it's in cities' best interest to figure out how to quickly convert office-centric downtowns into something more suitable for everyone.

Emil Skandul is a writer on technology and urban economics, and a Tony Blair Institute fellow.