Office Space Market Faces “Economic Downturn” Due To Perfect Storm Of Factors

More than two years after the virus pandemic upended the world of work, signs of distress in commercial real estate markets are emerging. The world is transitioning from an artificial landscape of ultra-accommodative monetary and fiscal stimuli that inflated returns to an environment where the federal government and the Federal Reserve tighten financial conditions. Given work from home has become a more permanent feature of the labor market and the souring macroeconomic backdrop, commercial real estate may be on the brink of a downturn. 

Goldman Sachs’ Chandni Luthra recently pointed out to clients that commercial real estate trends are cooling amid tightening financial conditions. 

“With intensifying concerns around widespread macroeconomic slowdown, and surging interest rates, real estate transactions and leasing activity continue to cool down, and the market is now factoring in an increased probability of an economic downturn over the next 12-18 months,” Luthra wrote.

Combine the tougher economic backdrop with companies taking steps to further reduce their office footprints because of new working patterns, and the office property market has a looming downturn “that could feasibly prove sharper even than the seismic crash of 2007-8,” FT’s Patrick Jenkins opined. 

Property markets have long been notoriously cyclical but the upturn of recent years has been just as dramatic as that crash, thanks to persistently cheap financing and a desperate search for investment returns. Both factors were the result of ultra-low central bank rates, deployed first to fan the post-2008 recovery, then to stave off a catastrophic downturn when Covid was unleashed on the world.

But as night follows day, bust in real estate markets follows boom. And with the Federal Reserve, the Bank of England and the European Central Bank all now in tightening mode, real estate agents acknowledge the good times are over. It is only a question now of how bad it gets. CBRE last month spoke of a “marked slowdown everywhere” thanks to the speed of interest rate rises, which had “taken us all by surprise.” -Jenkins

Last week, the Biden economy stumbled into a technical recession, and the very sight of a downturn has already impacted business operating decisions. 

Companies like business-listings provider Yelp Inc. and cloud-based software company Salesforce, Inc. scrutinized their space needs amid high inflation, concerns about an economic downturn, and hybrid work. These office space reductions will boost vacancy rates in major markets, if not already, and impact loans backed by office buildings. 

FT’s Jenkins questions how bad the coming CRE downturn gets. 

He cited a recent SSRN study that found US office real estate could decline long-term by 28%, or $500 billion. Across the Atlantic, Bank of America analysts warned that 12% declines in European office values were possible within the next 18 months. 

Recession and the cost of job loss plus a new world of work are indications of a bleak outlook for the office space market and how a downturn is imminent.