It’s been a year and a half since McKinsey published Empty spaces and hybrid places: The pandemic’s lasting impact on real estate. The comprehensive report examined the effect the COVID-19 pandemic had on behaviors, including office attendance, residential moves from urban centers to the suburbs, and in-person versus online shopping. It then modeled what the demand for office, retail, and residential space could be by 2030 in nine major global cities.
McKinsey Senior Partner Aditya Sanghvi tells McKinsey Global Publishing’s Katy McLaughlin what data held true, what’s changed, and how accurate the report’s forward-looking scenarios appear today. He describes new opportunities for a variety of asset classes in the wake of change and lays out the steps leaders of cities and real estate companies can take to revitalize urban cores.
This interview has been edited for clarity and length.
Katy McLaughlin: The press has recently been talking about some major companies mandating that people return to the office, so I’m guessing office attendance figures may have changed since the report’s release.
Aditya Sanghvi
Aditya Sanghvi’s headshot
Aditya Sanghvi: Headlines may give you that impression, but in fact, the office attendance and occupancy figures we modeled continue to look accurate.
The report found that by October 2022, office attendance was down by an average of about 30 percent compared with before the pandemic. In the cities studied, office workers were visiting the office about 3.5 days a week, on average. We’ve been keeping track of other sources that provide evidence that office attendance hasn’t meaningfully changed since we conducted our research.
Perhaps the biggest news today is that attendance and occupancy haven’t declined further, which was not an entirely settled question when we released the report.
It’s true that companies are continuing to experiment with return-to-office mandates. At many of these companies, though, the managers themselves also want hybrid work; the report found that higher-paid employees often embrace remote work the most. People find ways to not be in the office 100 percent of the time.
Katy McLaughlin: The report modeled moderate and severe scenarios for nine cities. How does office demand look now?
Aditya Sanghvi: Demand today maps to our moderate scenario, one in which by 2030, demand for office space is as much as 20 percent lower than it was in 2019, depending on the city. In this scenario, by 2025, office attendance is higher than it was right after the pandemic but still lower than it was before the pandemic, and the amount of office space demanded in most cities does not return to prepandemic levels for decades. A total of $800 billion—in real terms—of value is at stake by 2030, and, on average, the total value of office space is expected to decline by 26 percent from 2019 to 2030.
It’s important to note that the model considered the office, retail, and residential products on offer at the time. But there have been huge behavioral changes since 2020, and there’s an opportunity for commercial real estate to create new products and services that meet a new set of needs.
It’s about offering a new type of office that makes people want to come in, but it doesn’t stop there. It’s also about making sure retail real estate supports experiential retail, so that retailers that have seen a drop in foot traffic from commuters can create compelling reasons for people to come shop. It’s about recognizing that more people are working alone in their homes and that residential real estate can fill the socialization gap with communal spaces and programming. It’s about bringing retail experiences, services, and activities—that downtown vibrancy—to the suburban locations where many people moved.
Katy McLaughlin: Speaking of moves to the suburbs, the report said that several major cities’ urban cores lost population during the pandemic. This was part of the reason foot traffic near stores in metropolitan areas remained 10 to 20 percent below prepandemic levels. Have there been any reversals in urban population and retail statistics?
Aditya Sanghvi: There haven’t been reversals, but there also hasn’t been the outflow level that was seen during the pandemic. That means that during the pandemic, there was a one-time outflow that was greater than historical trends. Things have reverted to historical trends, which still show slightly negative shifts out of urban cores, which are expected given low affordability in some of them.
Our moderate scenario indicated that there would be 9 percent less demand for retail space in the median city studied. With fewer people living in urban cores and fewer people going to the office, foot traffic declines. Particularly in office-dense locations, vacancy in retail space has increased and rents have declined.
But again, this model captured where demand could land if the product continues to just rely upon the captive audience of daily commuters. Forward-thinking real estate owners and operators can think about working with retailers to create experiential draws and boost omnichannel sales, assembling a symbiotic collection of tenants (often using new AI tools), providing programming that energizes the community, and more. The important thing is for real estate companies to recognize what has changed and come up with a plan to change with it.
Katy McLaughlin: How does lease length affect how drops in demand play out in the marketplace?
Aditya Sanghvi: For office spaces, the average lease is five to ten years. So, it’s pretty hard to move the whole market really quickly because a 10 percent drop in office demand might actually be 100 percent of the space that becomes available in a given year. Long-term leases mean the market doesn’t see as many big fluctuations as the demand change might suggest.
For retail spaces, the average lease is five to seven years. So, the owners of retail real estate also have protection, but there’s a bit more flow than with offices. However, a difference in retail is that tenants are more concentrated. Consider a retailer that has hundreds or even thousands of outlets around the world. Cutting back on how much space they use could have a big impact on the total retail real estate market.
Katy McLaughlin: If fewer people come into the downtown office, fewer shop at nearby traditional retail stores. If there are fewer stores and restaurants in the vicinity, there’s less reason to attend the office. Are some cities taking definitive action against these proverbial “doom loops”?
Aditya Sanghvi: Not really. In many situations, you have to get the public sector and the real estate industry to work in lockstep about what to do, and that can be hard. To repurpose a defunct office building for a better use, zoning commissions would have to allow it, city governments may have to provide subsidies to help get it done, and real estate developers would have to want to do it. Getting that consensus can lead to political challenges, among other obstacles.
Katy McLaughlin: What steps could city and real estate leaders take in this new year to break such impasses?
Aditya Sanghvi: Many stakeholders are just hoping demand will eventually bounce back. Step one is to recognize the reality of the shift in demand.
Step two is to get all stakeholders thinking, “What is the ideal use of this space?” City leaders may have to rethink their plans for specific areas and reimagine what they could be. The report found that cities with real multiuse areas, where people live, work, and shop, fared better through the pandemic. There could be lessons there.
Step three is to facilitate the shift of the space. Real estate valuations take a long time to move because there’s no mark to market in real estate. But if city leaders could mitigate a buyer’s risk by enabling entitlement changes, deals could move faster. They could also consider incentives for completed transactions.
Another step, concurrent with the above, is for governments to provide incentives and subsidies that would attract companies and possibly higher education institutions to central business districts. Companies like to be located where they can find the talent they need.
Once you get all this in place, foot traffic returns to downtowns, and then retail can follow.
Katy McLaughlin: What about on the tenant side? Are companies succeeding in reinventing the office for a new era?
Aditya Sanghvi: Many users of office space are reimagining offices as more dynamic spaces, and that’s encouraging people to come in. They’re upgrading food and beverage. They’re programming days of the week when teams come in to work together. They’re creating digital experiences that enable employees to order food to be delivered to their desks, book rooms they need, or use their smartphones to get their dry cleaning handled.
And in fact, buildings that are new, newly developed, or newly renovated and in great locations are doing incredibly well from a rent perspective. There is a lot of demand for the highest-quality office product.
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