Empty offices could cause ‘fiscal doom loop’ in Philly and other big cities

This autumn, as big employers such as Comcast are asking employees to come back to the office at least a few days a week, the business-dominated corners of Center City are feeling more active than they have since March 2020. With the hybrid experiment in full swing — barring any new, deadlier variants of COVID-19 — some office workers are seeing something like a return to normalcy.

A new study, however, warns that there’s probably no going back to 2019.

A research paper published by the National Bureau of Economic Research shows that the damage to the office sector caused by the rapid rise of remote work could be deep and lasting, predicting an “office real estate apocalypse” if trends continue. It finds that even newer buildings with more amenities, which have seen more robust leasing, could see a 20% cut in value.

The study’s authors looked at New York City and estimate a 39% decline in how much office buildings in that city could be worth by 2029, which could lead to $49.57 billion in value destroyed. If New York’s trend applies to the national level, the lost value could total $453 billion.

“These are shocking numbers,” said Stijn Van Nieuwerburgh, professor of real estate with Columbia University’s business school. “There’s nothing specific to New York in these numbers or in the logic of our argument.”

Van Nieuwerburgh said that Philadelphia office lease revenues are down by 20%, even lower than their New York counterparts.

Office vacancy rates in Center City, meanwhile, are the highest they’ve been in at least 10 years, according to commercial property analytics firm CoStar Group. In Center City, only 87.9% of office space was occupied in the the third quarter. The numbers are similar in the Philadelphia suburbs, where 88.5% of office space was occupied. In King of Prussia, 83.4% of offices were occupied.

The ramifications of a radical revaluation of office buildings would have wide-ranging effects. The most direct losers would be building owners, which often include institutional investors.

“A lot of these offices are held by a pension funds, retirement funds, sometimes sovereign wealth funds,” Van Nieuwerburgh said. “In cities that are hit pretty hard by this, they’re going to potentially lose their entire investment.”

The public sector would not escape the fallout, either. Cities dependent on commercial property taxes would be hit hard by a permanent and deep decline in the value of the office sector. Van Nieuwerburgh warns of a “fiscal doom loop” for municipalities akin to the urban crisis of the 1970s and 1980s, in which budget holes must be filled by higher taxes and service cuts, which drive more affluent residents away and spur further contraction.

“Cutting spending means reducing expenditures for transit, for education, for police departments,” Van Nieuwerburgh said. “And so the issues we have for crime, for example, might get worse as these budgets come under further pressure.”

Philadelphia would not suffer from such a scenario in the same way as New York, Washington, or San Francisco, where high-rise offices have historically been one of the strongest pillars of the tax base.

That’s because Philadelphia relies to an unusual degree on residential property and wage taxes. Property tax revenue provides only about one-sixth of the city’s general fund, far lower than in peer cities, according to Pew Charitable Trusts, and 71% of that comes from residential dwellings. But in combination with uncertainties surrounding future wage tax revenue, which is also imperiled by remote work, the effects could be meaningful.

Van Nieuwerburgh argues that conversion of older office buildings, especially pre-World War II-era structures, into apartments would be an ideal way to revive value and address the housing shortage suffered by many major American cities.

In Philadelphia, that is easier said than done. Many of the city’s pre-war offices were converted to housing before the pandemic, and the buildings from the late 20th century have large floor plans and vast interior spaces with little access to sunlight. These will prove difficult and expensive to modify for residential purposes but are still too old to be appealing in a hyper competitive COVID-era office market.

“If nobody wants to sell their office at prices that are the only feasible prices to do the conversion, then this will not happen,” Van Nieuwerburgh said. “It might just be that some of that 1980s-style office will have to be demolished.”

Editor’s note: An earlier version of this article contained erroneous office occupancy rates provided by CoStar Group. The article has been updated to include their corrected data.