Report: Employers intend to downsize further as questions about office space utilization linger

Coming out of the pandemic, there’s more available office space than ever before. Through the first three quarters of the year, the national office vacancy reached 17.8 percent by the end of September, according to the latest National Office Report from the real estate software company Commercial Edge. At least in the short term, there’s indication that the trend will continue.

A new report from Robin found that, while employees are returning to in-person work, offices are smaller, and companies intend to downsize further because there’s so much underutilized space. This is notable for local governments, as commercial real estate has historically been a reliable source of revenue.

“When you consider utilization rates and the cost of leases, it’s not particularly surprising to find out that 75% of businesses plan to reduce office square footage next year. That’s nearly a 30% increase since 2022, suggesting that companies may have been waiting for utilization to rebound before making a decision,” the report reads.

According to the research, more than 80 percent of companies surveyed are worried about spending too much on un-necessary square footage.

All of the empty space is driving down commercial property values, putting city governments “on shaky ground,” reads a brief from the Tax Policy Center, a joint initiative from the Urban Institute and the Brookings Institution. “The divergence in commercial and residential property values makes it hard to predict the fiscal consequences for local governments broadly. Total property tax revenue accounts for 30 percent of local general revenue, but the pain from this transition will likely be concentrated in major cities with big commercial districts.”

This has raised alarm bells in many city halls. In March, a group of commercial real estate owners and operators in Washington, D.C., sent a letter to the city’s chief financial officer warning of serious fiscal implications if the commercial real estate market were to crash. The CFO, Glen Lee, later published an estimate projecting the reduction in real estate property tax revenues could total $464 million over the next three years.

In San Francisco, $2.5 billion of its expected $6.4 billion in revenue for fiscal year 2023-2024 is expected to come from property taxes. And as of this summer, city officials there warned that as much as a third of the city’s offices remain vacant. Notably, because leases tend to be long term, the current vacancy right might not entirely capture the true state of empty offices.

In his brief published for the Tax Policy Center, Thomas Brosy, a research associate, outlined three possible ways local governments can react to the changing reality of commercial office space.

“One, they could increase the tax rate on commercial properties. This might raise revenue, but it could also increase the tax burden of commercial tenants and put further downward pressure on demand, exacerbating the core problem,” the article reads. “Two, they could curtail spending and services. This might help cities balance budgets, but it could potentially harm the city’s most vulnerable residents and make it a less attractive place to live and do business. “Third, they could make up for the shortfall by increasing tax revenues from other sources, such as residential property, sales taxes, or fines and fees. However, this could make these local tax systems more regressive.”

For now, there’s still a lot of uncertainty as work trends continue to fluctuate. But if the latest analysis from Robin is an accurate indicator, and employers do decide what to do with their office space, the commercial real estate market could be turning a corner soon.

“Notably, the number of businesses mandating 4 days a week in office has increased 32% since 2022 with a 16% decrease in 3 day mandates. While it’s clear that in-office time is more of a priority this year, it’s important to note that the majority of companies surveyed are working on a structured hybrid schedule, with some in-office time and some level of flexibility reported,” the report says.