Get ready for a big downturn — America's 'office apocalypse' is even

worse than expected

Story by insider@insider.com (Emil Skandul) • 2h ago

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

Remote work is gutting downtowns, forcing leaders to reinvent the post-pandemic city.

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. 

How much you'd pay per month for a typical home in 6 US cities where prices
have fallen but mortgage rates are on the rise

• Mortgage-rate hikes are throwing cold water on homebuyer activity.

• Less demand has led to home-price declines in several markets across the country.
• Insider compared the typical monthly payment on homes in six US cities where prices
are falling.
A short walk around your neighborhood could tell you that the housing market is going
through something.

Whether you live in the quiet suburbs of Seattle or the busy streets of downtown
Nashville, you're probably seeing fewer "for sale" signs in front yards and smaller asking
prices. It's part of the housing market's cooldown.

Gone are the days of intense buyer competition. America's new housing ecosystem has
a limited number of home listings, fewer buyers, and, ultimately, lower home prices. But
that doesn't mean homeownership has become any more affordable.

For many Americans, housing is more expensive than ever before. New homeowners
are suffering from a double whammy of high inflation and rising interest rates. That's led
to mortgage-rate hikes that have offset affordability gains obtained through slowing
price appreciation.

Freddie Mac indicates that the average rate on a 30-year fixed-rate mortgage is at its
highest since April 2002. In most cases, homebuyers are facing rates that have nearly
doubled since 2021.

"For the typical mortgage amount, a borrower who locked in at the higher end of the
range would pay several hundred dollars more than a borrower who locked in at the
lower end of the range," Sam Khater, the chief economist at Freddie Mac, told Insider.

To get a sense of how rates are affecting affordability, Insider examined six home
buying hot spots where prices have been falling, then used home-price data sent to us
from Zillow to determine each market's peak home value during the latest boom as well
as its typical home value today.

Using mortgage rate data from Freddie Mac, we then calculated how much the monthly
payment would be for a homebuyer if they had locked in a mortgage at their market's
peak — when rates were much lower than they are today — and how much they'd pay if
they were to lock in at current rates.

In today's rate environment, assuming a homebuyer makes a 20% down payment and
chooses a 30-year fixed-rate mortgage, a slashed listing price doesn't always mean a
home has become more affordable.

This was the case for Austin, Texas, where if a buyer had purchased a home worth
$602,894 in May — when prices reached a peak in the city — and got a mortgage rate
of 5.09%, their monthly payment would be about $2,616.

But if they bought a home now, when the typical home value is $553,280, and locked in
a rate of 6.94%, their monthly payment would jump to nearly $2,927.

Read on to see how mortgage rates are affecting housing affordability in other parts of
the country.
See More

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.

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 pre-pandemic. 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.