In its original projections about the impact of the pandemic on the office sector, Capital Economics said office occupancy would decline by 7% to 8% by 2025, however, “vacancy rates will rise significantly and remain high” through 2030. Those lower will lead to lower occupancy levels and lower Rents will lead to a 20% decline in portfolio income by 2025, while net operating income will remain below pre-pandemic levels during the decade.
Now, the research firm suggests that “the 35% decline in office values that we project by the end of 2025 is unlikely to recover even by 2040,” in New report Posted on Thursday. This means that offices are unlikely to regain their peak values in the foreseeable future, or in the next 17 years, according to Capital Economics. This is because demand dropped dramatically after the shift to remote work that emerged from the pandemic.
In the report, written by Capital Economics deputy chief real estate economist Kiran Raichura, he likens the decline in office demand to the experience of shopping malls over the past six years with consumers’ tendency to shop online. There is no real recovery in the mall sector that has been plagued by structural headwinds, Raishura said, and Capital Economics expects the office sector to not be much different.
“We expect office owners to face a similar fate over the next few years, with the potential for a rapid recovery in the relative performance of a sector that appears weak despite the sharp declines experienced thus far,” Raishura wrote.
like Wealth I mentioned earlier that all commercial real estate is vulnerable to interest rate hikes from the Federal Reserve since it is built largely on debt. So as interest rates go up, so does the cost of borrowing, and that can sometimes lead to payment delays and defaults. But, moreover, the office sector is experiencing a lack of demand because people are working from home – which is why it is considered the most vulnerable sector.
Raishura said they have the data to support that view, comparing offices to malls. Raishura first pointed to a global survey by Knight Frank and Krisa that recently found that 56% of companies have adopted a hybrid business model, which he said corresponds to lower rates of actual office utilization, such as office keycard swipes approaching 50% of business levels. Early 2020 (which was only between 70% and 75%). For this reason, companies are moving to save physical space. Citing real estate information standards data, Raishura said office vacancies rose from 16.8% in the last quarter of 2019 to 19% in the first quarter of this year. However, this may not be entirely representative of the current situation.
“The real increase is almost double that when the sub-letting function is taken into account,” Raishura wrote in the report. “And there is probably more to go into. As a result, job vacancies have already seen an increase greater than the 3.5% point increase in malls between the second half of 2016 and the first quarter of 2023.”
Although net operating income for offices was actually higher in the first quarter of this year than in the first quarter of 2020, according to the report. Office investors are still treading cautiously. Raishura writes that major lenders have returned stranded office assets to investors and that is likely to continue over the next two years given the sharp increase in mortgage-backed securities delays in May.
“REIT investors are also staying away from desks,” Raishura wrote. “After little more than three years of economic downturn, the desktop REIT total return index is down more than 50% compared to the all-stock REIT index. This roughly equals the decline in the regional mall REIT total return index in the first few years of a sector correction. fragmentation”.
The office sector hasn’t bottomed out yet, which is why Capital Economics notes that office values are unlikely to return to pre-pandemic levels even 17 years from now. However, if they did, there would be some caveats.
“Demolitions and worse asset conversions may partly counteract the impact on valuation-based indices, but ultimately owners will have to bear these costs, so the road ahead for office owners will be uphill,” Raishura writes.