U.S. office values may fall 10% to 20% in the coming years in the likely case that the corporate world settles into a hybrid office-work setting, according to a new report from the Mortgage Bankers Association.
But the decline is unlikely to come all at once, the report said, thanks to the long-term nature of office leases prompting a more gradual reduction in office space that companies occupy.
"That's going to be working itself out over a decade," said report co-author Jamie Woodwell, MBA's vice president of commercial real estate research. "It is a slower, longer-term adjustment than what you would see in other property types, like what we saw with hotel and retail during the teeth of the pandemic."
That outlook may offer some relief to the banking industry, where executives have spent two years monitoring the health of their office-related commercial real estate loans as companies debate the future of work.
The industry itself is grappling with those same questions. Synchrony Financial in Stamford, Connecticut, is giving its employees the option to work remotely permanently, while some Wall Street banks are pushing for a return to in-person work and others gauge
The MBA report examined two possible scenarios for office values depending on how the future of work shakes out, noting that the future is likely somewhere between the two.
One scenario would assume that employees and employers alike see far more benefits than drawbacks to in-office work — such as more collaboration and a greater likelihood of meeting higher-ups, which may help employees land promotions.
Under that scenario, employees would spend three or more days a week in the office, employers would use about the same amount of space, and office values would be around pre-pandemic levels — though not before seeing some volatility.
But the more likely base-case scenario assumes that companies would settle on a remote or hybrid model, and employees would go into the office for two or three days a week.
Companies would use about 80% of the office space compared to pre-pandemic levels, and the values of different properties would vary depending on their location and type of property. Offices with "premium" space for collaboration, for example, would be more valuable than lower-quality spaces.
The agency acknowledged that loan performance in the sector has been strong, but cited several reasons to think that might change, including rising interest rates, the effects of inflation and uncertainty about the future of work and commerce.
But the amount of long-term office leases outstanding today means that buildings will not "be empty overnight," said Matthew Anderson, managing director at the commercial mortgage analytics firm Trepp.
"There may not be some watershed moment where everybody is dropping office entirely, and it turns from being problematic to being an actual problem," Anderson said. "More likely, it'll continue to be a slow leak, sort of a neglected sector."
Right now, Anderson said, banks are "still making office loans" but are originating fewer, a function of reduced demand from companies but also tighter underwriting criteria that are pulling them away from riskier projects.
Valley National Bancorp executives, for example, said in April that they do not have a large exposure to office buildings but that they were still cautious on the sector.
"We're very conscious of what's going on in the office space and very careful in how we proceed there," Valley President Thomas Iadanza said on the New York City bank's first-quarter earnings call.
PNC Financial Services CEO William Demchak, meanwhile, told analysts in July that the bank is worried about the "slow burn" that the office sector is experiencing but that the Pittsburgh bank was "really well reserved" against a negative scenario.
To gauge potential scenarios, the MBA report looked at the real estate crash that hit San Francisco following the dot-com bubble. But the authors also cautioned that many tech firms declared bankruptcy at the time and nullified their leases, while the pandemic has not prompted a similar wave of collapses.
"Any readjustment of office leases resulting from changes in work-from-home or other demand will be strung out over a decade, as opposed to the three years seen in San Francisco in 2001," the report said.
Allissa Kline contributed to this article.
