When the pandemic began, most analysts predicted that commercial real estate would be one of the hardest hit industries. The exodus from urban centres and the collapse of high street retailers left property companies reeling. Another cloud hung over office real estate, as staff switched to working from home and anchor tenants threatened to move out of longtime bases in New York and London, Hong Kong and Shanghai. The only question was: would office workers come back, and if so when?

While there has been a slow return to office work, the data so far shows that spaces are not back to anything close to their pre-pandemic normal: US office occupancy was still at only 43 per cent as of April 2022, according to the property management firm, CBRE. This may be a long-term trend. Just over half of respondents to a recent survey by the law firm DLA Piper predicted a permanent increase in the number of workers who spend less than 50 per cent of their time working in office buildings.

In addition to the disruption caused by remote working, commercial property is now facing stronger financial headwinds, as central banks around the world raise interest rates to try to tame soaring inflation. Rising rates and recessionary fears are now cooling sales and valuations of London office property, despite a strong first half-year.

Leasing volumes and office construction have slowed in New York. Rents are underperforming in big cities compared with suburbs. Wall Street has begun to take note, with commercial real estate lending tightening. One apocalyptic prediction by an academic study forecast a decline of 28 per cent in New York City’s office property over the next decade — the latter representing $500bn in potential value destruction.

The cracks caused by the pandemic commercial real estate could risk developing into structural damage. This has obvious financial implications, not just for the sector but also for institutional funds that invest in office buildings. Pension funds are significant holders of London office blocks, for instance. Open-ended property funds are also popular with British retail investors. Before the pandemic, these funds held about £21bn of assets in the UK. Regulators have long been worried over such funds’ “liquidity mismatch”: the difference between the time it would take them to sell property assets and their offer of daily withdrawals to customers, particularly when markets are volatile. 

While some guardrails have been put in place, the fundamental issue remains. Efforts to improve funds’ liquidity management, both at a UK and international level, have been delayed. While retail investors should be at liberty to make bad investment decisions, policymakers have a responsibility to outlaw irresponsible investment structures.

Uncertain times mean it is imperative that officials, companies and developers think about what cities should look like. Developers are starting to offer more flexible terms on leases. There has been a flight to quality, with newer, more energy efficient, more considered buildings filling up, while lesser properties languish. Good design — with buildings offering amenities that might lure workers back to the office — will be key.

Some of this is a welcome Schumpeterian culling of an old paradigm that no longer makes sense. With 9 to 5 workdays a thing of the past for many, hybrid working makes sense for those whose jobs allow. In London this summer, remote working proved its resilience once more: staff were able to work when industrial action, then extreme heat, halted rail commutes.

Still, the implications of the shifts in commercial property for both financial markets and the funding of public services have yet to be grappled with. It is time for public and private sector leaders to start thinking more deeply about what all the changes will mean, and how to buffer disruptions.