REPORT: Office Values Unlikely To Recover Before 2040

The value of office space driven by the rise in remote work will continue plunging sharply for the next two years and is unlikely to recover before 2040, according to a new report from Capital Economics. 

Shifting office demand could result in a 35% decline in office values by the end of 2025, according to the report from the London-based research firm. Rising office vacancy would lead to a 20% drop in portfolio incomes by 2025, researchers wrote in the report, with net operating income falling below 2019 levels through the end of this decade. 

“For offices, with more of the downturn still to play out and a similar peak-to-trough fall in prices [as experienced by regional malls] in our forecast by end-2025, values could struggle to regain their pre-pandemic peaks even by 2040,” Kiran Raichura, deputy chief property economist at Capital Economics, wrote in the report. “Even if they did so, this would still leave them dramatically lower in real terms.” 

The sluggish recovery of office foot traffic is driving down property values. Office keycard swipes remain close to 50% of early 2020 levels and 56% of firms have adopted a hybrid model while a further 12% plan “fully flexibly” work models, according to a global survey by Knight Frank and Cresa cited in the report.

Office vacancy rose from 16.8% in the fourth quarter of 2019 to 19% in the first quarter of 2023, according to REIS data cited in the report. 

Uncertainty in the future of office space is driving away investment and forcing major landlords to hand keys to properties back to lenders. CMBS loan delinquency for office assets jumped 128 basis points in May to 4.2%, according to a Trepp report, the first time office asset delinquencies were above 4% since 2018. 

“If the sharp uptick in delinquent CMBS in May is anything to go by, lenders face being lumbered with many more office assets over the next couple of years,” Raichura wrote in the Capital Economics report. 

REIT investors are also turning away from office space. The office REIT total returns index is down by more than 50% relative to the all-equity REIT index. 

The headwinds in the office investment sector mirror the decline in value that American malls experienced in the last six years, Raichura wrote. Rising online sales have led to a fall in demand for brick-and-mortar shops, and net operating income at regional malls fell 11.3% from the end of 2016 to the first quarter of 2023. 

Regional mall values have only recently begun to stabilize after more than six years of decline, according to the report. With mall valuations down by 33.5% in absolute terms, Raichura wrote that it could take until the mid-2030s for mall assets to recover to their previous peak. 

“The reduction in office demand due to remote work will cause a hit to NOIs on a par with, or worse than, that experienced by malls over the last six years,” Raichura wrote. “And in line with the experience of malls, the structural nature of this hit to demand means the 35% plunge in office values we’re forecasting by end-2025 is unlikely to be recovered even by 2040."

Creative repositioning of office assets and the redevelopment of older buildings could offset some of the decline in values. But the costs of converting or upgrading a space will fall on owners who are already struggling with the declining value of their assets. 

“Demolitions and conversions of the worst assets may partially counteract the impact on valuation-based indices,” Raichura wrote. “But ultimately landlords will have to bear those costs, so the road ahead for office owners is set to be an arduous one.”