“I’m about to cancel all my Zoom meetings.” It was May 2021, and Jamie Dimon had had enough. The JPMorgan Chase CEO expected that “sometime in September, October,” the company’s office would “look just like it did before.” Two years later, his company is slashing its Manhattan footprint by a fifth.
Post-pandemic, kids are back in school, retirees are back on cruise ships, and physical stores are doing better than expected. But offices are struggling perhaps more than most casual observers realize, and the consequences for landlords, banks, municipal governments, and even individual portfolios will be far-reaching. In some cases, they will be catastrophic. But this crisis, like all crises, also represents an opportunity to reconsider many of our assumptions about work and cities.
During the first three months of 2023, U.S. office vacancy topped 20 percent for the first time in decades. In San Francisco, Dallas, and Houston, vacancy rates are as high as 25 percent. These figures understate the severity of the crisis because they only cover spaces that are no longer leased. Most office leases were signed before the pandemic and have yet to come up for renewal. Actual office use points to a further decrease in demand. Attendance in the 10 largest business districts is still below 50 percent of its pre-COVID level, as white-collar employees spend an estimated 28 percent of their workdays at home.
With a third of all office leases expiring by 2026, we can expect higher vacancies, significantly lower rents, or both. And while we wrestle with the effects of distributed work, artificial intelligence could drive office demand even lower. Some pundits point out that the most expensive offices are still doing okay and that others could be saved by introducing new amenities and services. But landlords can’t very well lease all empty retail stores to Louis Vuitton and Apple. There’s simply not enough demand for such space, and new features make buildings even more expensive to build and operate.
With such grim prospects, some landlords are threatening to “give the keys back to the bank.” Over the past few months, the property giants RXR, Columbia Property Trust, Brookfield Asset Management, and others have collectively defaulted on billions in commercial-property loans. Such defaults are partly an indication of real struggles and partly a game of chicken. Most commercial loans were issued before the pandemic, when offices were full and interest rates were low.
The current landscape is drastically different: high vacancy rates, doubled interest rates, and nearly $1.5 trillion in loans due for repayment by 2025. By defaulting now, landlords leverage their remaining influence to advocate for loan extensions or a bailout. As John Maynard Keynes observed, when you owe your banker $1,000, you are at his mercy, but when you owe him $1 million, “the position is reversed.”
Banks have many reasons to worry. Rising interest rates have devalued other assets on their balance sheets, especially government bonds, leaving them vulnerable to bank runs. In recent months, Silicon Valley Bank, First Republic, and Signature all collapsed. Regional institutions like these account for nearly 70 percent of all commercial-property bank loans. Pushing down the valuation of office buildings or taking possession of foreclosed properties would further weaken their balance sheets.
Municipal governments have even more to worry about. Property taxes underpin city budgets. In New York City, such taxes generate approximately 40 percent of revenue. Commercial property—mostly offices—contributes about 40 percent of these taxes, or 16 percent of the city’s total tax revenue. In San Francisco, property taxes contribute a lower share, but offices and retail appear to be in an even worse state.
Empty offices also contribute to lower retail sales and public-transport usage. In New York City, weekday subway trips are 65 percent of their 2019 level—though they’re trending up—and public-transport revenue has declined by $2.4 billion. Meanwhile, more than 40,000 retail-sector jobs lost since 2019 have yet to return. A recent study by an NYU professor named Arpit Gupta and others estimate a 6.5 percent “fiscal hole” in the city’s budget due to declining office and retail valuations. Such a hole “would need to be plugged by raising tax rates or cutting government spending.”
Many cities face a difficult choice. If they cut certain services, they could become less attractive and trigger a possible “urban doom loop” that pushes even more people away, hurts revenue, and perpetuates a cycle of decline. If they raise taxes, they could alienate wealthy residents, who are now more mobile than ever. Residents making $200,000 or more contributed 71 percent of New York State’s income taxes in 2019. Losing wealthy residents to low-tax states such as Florida and Texas is already taking a toll on New York and California. The income-tax base of both states has shrunk by tens of billions since the pandemic began.
Finally, turmoil in office markets threatens retirement systems and the portfolios of individual people. Public and private pension funds have traditionally kept their assets in stocks, bonds, and cash. However, in recent decades, they have shifted toward so-called alternative investments, including commercial real estate and private equity. These investments now comprise a third of their portfolios, with real estate comprising more than half of these assets for many pension funds.
Pre-COVID, this trend included significant investment in office space, particularly in major markets such as New York, San Francisco, Los Angeles, and Boston—which are now struggling. Pensions saw this type of investment as a stable source of income, mainly through rent, and a hedge against inflation. With public pensions already underfunded by an estimated $1 trillion, a decline in the value of commercial real estate could make this bad situation significantly worse.
You get the idea. Office buildings pose a threat to a variety of financial institutions. As more leases and loans come due, the bulk of the pain is still ahead of us. Over the next two years, many downtowns will find that dozens of buildings are no longer fit for purpose. Municipal services will likely deteriorate, and more people might leave. The worst-case scenario is a return to the 1970s, with bankrupt municipal governments, rising crime, and the flight of (primarily white) upper-middle-class residents. Landlords like to point out that “New York always comes back.” But some cities—like Detroit or Pittsburgh—never recovered from the previous waves of technological change. And even in New York, a comeback may take decades.
In the ’90s, the internet helped cities come back. As the economy became more dependent on innovation and creativity, many of the largest and densest downtowns boomed. In 2007, the world’s preeminent urban economist, Ed Glaeser, called it a “central paradox of our time” that cities remain “remarkably vital despite ever easier movement of goods and knowledge across space.” Economists have been busy explaining this paradox up until the current crisis. As the theory goes, companies require the rapid exchange of ideas and specialized division of labor that large cities provide. In addition, companies want access to the largest possible talent pool, and top talent likes to live in large cities because of lifestyle considerations.
The consensus among economists was that as technology and media expanded, economic activity would consolidate within a select few superstar cities. But even before COVID, the theory started to crack as some of the top-performing cities saw population decreases, tech giants started distributing their offices across smaller cities, and the office market was propped up by WeWork’s irrational, venture-capital-funded expansion.
The pre-COVID consensus wasn’t wrong, but the leading thinkers did not consider the full implications of their own theories. Once the quality of online collaboration crossed a crucial threshold, the internet itself became the largest talent pool and the premier facilitator of human interaction. And once highly educated individuals could earn a nice living from anywhere, lifestyle preferences became more diverse. This does not mean that superstar cities are doomed, but it does mean that their previously captive audience now has more options.
Cities will have to survive and adapt. In a world of consumer choice, locations must think like consumer products. One way to win is to double down on what only the biggest cities can offer—walkable streets, car-free transportation, and cultural and intellectual diversity. But smaller cities can emphasize shorter commutes, ample parking, proximity to nature, better schools, and lower taxes.
And then there’s the nitty-gritty. Most offices will chug along, under new ownership or in the hands of investors who will have to wait longer to recoup their investment. Many old buildings will have to be converted to other uses or demolished. Steve Paynter, a principal at the design firm Gensler, has been evaluating hundreds of office buildings across North America and estimates that as many as 30 percent of them could be fit for residential conversion. Other buildings could accommodate new uses, including health care, education, light logistics, and even data centers. To facilitate such conversions, cities must loosen existing zoning laws, streamline planning procedures, and provide tax abatements and other incentives. In the 1990s and early 2000s, New York City relied on this policy mix to convert 59 office buildings in lower Manhattan to more than 12,000 apartments.
Cities can also lean into public-private partnerships. Such partnerships bring public and private resources together to finance, build, and maintain public facilities and spaces. In the late 20th century, such partnerships in New York City helped rejuvenate Times Square, revive Bryant Park, build the High Line and Brooklyn Bridge Park, and fund the New York Public Library. When executed properly, public-private partnerships can inject billions into urban development without sacrificing the broader public interest.
Realistically, though, whatever resources cities can muster won’t be enough. The federal government will have to provide significant, ongoing assistance. In the ’70s, Vice President Hubert Humphrey called for a “Marshall Plan for the Cities,” drawing on an earlier suggestion from the civil-rights activist Whitney Young. In 1975, President Gerald Ford apocryphally told New York City to “Drop Dead” after the local government declared bankruptcy, but ultimately authorized billions of dollars in loans to bail out the city.
State governments will have to chip in as well. Many states depend on their large cities and have their own struggles. But local and state governments could coordinate to make better use of resources, speed up the approval of new projects, and pressure the federal government to provide more funding. This crisis is also an opportunity to renegotiate the fiscal boundaries among states, cities, and suburban counties. As the economist Richard McGahey pointed out, cities receive too little of the revenue they generate because many urban workers live—and pay taxes—in separate counties. This dynamic will be exacerbated now that hybrid workers can live even farther away.
Beyond matters of taxation and construction lies the biggest opportunity of all. As the Canadian writer Margaret Visser pointed out, “The extent to which we take everyday objects for granted is the precise extent to which they govern and inform our lives.” She was talking about forks and chairs, but her observation applies to our offices. These boxes of glass and steel determine the shape of our cities and the rhythm of our transportation systems. They dictate when we wake up, what we do, how far we live from our relatives, how much time we spend with our children—and whether we have any children at all. They permeate our culture and underpin our economy. Even before individuals are old enough to work, classrooms prepare us for life at the office. And once we retire, we rely on commercial property to provide stable income and protect the value of our savings. The office crisis is an opportunity for us to rethink these patterns.
