FRESH TAKES ON BIG IDEAS

This summer, the McKinsey Global Institute published “Empty spaces and hybrid places,” our comprehensive report examining the pandemic’s long-term effects on real estate. What we found is that the long-term impact really centers around the disruptive and lasting changes in how we work. Attendance in the office remains down by some 30 percent, and office space needs in 2030 are likely to be lower than they were in 2019. This change has had and will continue to have ripple effects on all other real estate asset classes.

We analyzed in depth nine “superstar cities” worldwide—cities with a disproportionate share of the world’s urban GDP and GDP growth. These were Beijing, Houston, London, Munich, New York, Paris, San Francisco, Shanghai, and Tokyo. In our research, we found that office demand in 2030 could be 13 percent lower than it was in 2019 in the median city in our moderate scenario, and 38 percent lower in a more extreme scenario, relative to prepandemic demand. Values could be 26 percent lower in our moderate scenario and 42 percent lower in our severe scenario, even before considering changes in capitalization rates. In just nine cities, we are talking about the potential loss of $800 billion in office real estate value.

It is important to understand that the demand decline is for the office space that is in use today, because to a large extent, the office product available today is no longer fit for purpose. As of fall 2022, employees were spending about 3.5 days per week in the office. Lower attendance is a way of expressing that workers don’t want to go back to the cube farms that continue to fill the vast majority of offices, or certainly not as frequently as they once did.

I haven’t given up hope for the office, but I do think landlords have to create a different relationship with tenants and provide services that actually help those tenants achieve better outcomes. Changes can include shorter, more flexible lease terms and analytics that provide insights into how space is used and how it should be designed. A landlord’s mindset should be that of a solutions provider, one who helps clients—and I’m deliberately saying clients, not tenants—to outperform. To beat the working-from-home alternative, spaces should “earn the commute,” and you do that by creating space where people actually want to work. Real estate players need to prove to employers that better workplaces can lead to higher attendance, increased employee engagement, and improved measures of productivity.

“In just nine cities, we are talking about the potential loss of $800 billion in office real estate value.”

It’s going to take collaboration between office owners, policy makers, and tenants to make the office a place where people want to be, which may then help to revitalize some of the urban cores that have lost a bit of that specialness. That’s a big imperative for cities.

Retail and residential spaces are also really important for city policy makers to consider when talking about what they need to do to revitalize, as both kinds of real estate can feed a virtuous cycle. Our report studied the effect of lower office attendance on retail real estate. Foot traffic remains 10 to 20 percent depressed in metropolitan areas, and the recovery has been even slower in urban cores, particularly in office-dense neighborhoods. When fewer people come to the urban core on a given day, fewer people shop or dine in the urban core. But if you have great retail, great experiences, and affordable living, then cities feel vibrant. If cities feel vibrant, workers may be more willing to make the commute. And if workers come in, then all that retail and residential real estate becomes more valuable for investors.

Policy makers might do well to start thinking of cities’ current challenges as an opportunity. After all, lack of space has long been one of the hardest problems confronted by major cities. Suddenly, that problem has eased. Policy makers asking themselves how cities can best take advantage of vacant space could contemplate having the right mix of attractive office, retail, and residential spaces. These kinds of vibrant neighborhoods were becoming more popular even before the pandemic, and our research shows that they suffered less than office-dense neighborhoods during the pandemic. Reforming restrictive zoning policies could be one step. And any policy changes that make office-to-residential conversion simpler may increase affordability. We are way better off converting obsolescent space to new purposes rather than allowing it to die a slow death in the coming years.

The pandemic created an earthquake, and now we’re dealing with the aftershocks. I think the imperative is incredibly strong to act, to act now, and to act collectively.

ABOUT THIS AUTHOR

Aditya Sanghvi is a senior partner in McKinsey’s New York office.

MORE FROM THIS AUTHOR

UP NEXT

Becca Coggins on redefining retail

The retailer of the future won’t just sell stuff—it might also become your walk-in clinic, your internet provider, your travel agent, and your bank. But as retailers seek to expand into new businesses, they need to make careful, consumer-centric choices.

Share these insights

Did you enjoy this newsletter? Forward it to colleagues and friends so they can subscribe too. Was this issue forwarded to you? Sign up for it and sample our 40+ other free email subscriptions here.