Prize-winning real-estate economist says the office market won’t improve for years: ‘This is a trainwreck in slow motion…

One of the most seismic changes from the pandemic is where we work. For many of us, that’s still completely or partially at home, leaving a major glut of office space where millions of Americans used to spend 40-plus hours per week. 

The appetite for offices is so low that there may be as much as 1 billion square feet of unused U.S. office space by the end of the decade, according to a report early this year by real estate firm Cushman & Wakefield. That’s nearly 1.5 times the amount of office vacancies at the end of 2019, just before the pandemic began.

It only took a couple of years for the office real estate market to hit a decades-low vacancy rate, but it could take much longer for it to rebound. The office vacancy rate is nearly 20%, according to CBRE, and market experts have little confidence it will improve soon. 

“It could easily take several years for the office market to stabilize, which is why I’ve referred to all this as a trainwreck in slow motion,” Stijn Van Nieuwerburgh, a professor of real estate and finance at Columbia Business School, told Goldman Sachs in its Commercial Real Estate Risks report released Monday. Van Nieuwerburgh is a highly regarded European economist who won the Bérnácer Prize, awarded to European economists under the age of 40 who make “outstanding contributions” to macroeconomics and finance research. 

He predicts impending doom for four reasons, the first being that it’s still unclear whether some leases from before the pandemic will be renewed. Because office leases have an average length of seven years, it will take several more years for all pre-pandemic leases to roll off, he explains.

“Many tenants have not made active space decisions yet and are waiting for their leases to expire to either reduce space or negotiate a better deal,” he said. “Both are bad news for landlord cash flows for years to come.”

Secondly, as vacancies continue to rise, rents will likely fall. Office vacancies are at a 30-year high, Julie Whelan, CBRE’s global head of occupier research, previously told Fortune. Although there has been “surprisingly little” lowering of office rents, Van Nieuwerburgh expects “downward pressure on market rents to increase in the near future.”

Another contributor to impending doom is landlords having to refinance mortgage loans. Typically, landlords take out 10-year mortgages that they then refinance at the end of the loan term. With mortgage rates at multi-decade highs, landlords are now feeling a lot more financial pain when they refinance.

“Interest rates have more than doubled, there are cash flow problems because of vacancy, and building values have fallen because of hybrid work and higher interest rates,” Van Nieuwerburgh said. “All of this means that lenders will not be willing to roll over the debt.”

Lastly, city tax assessments are completed infrequently, which could place a lag on helping determine commercial property values, Van Nieuwerburgh explained. For example, instead of determining commercial property values on recent comparable sales, New York City sets the value based on five years of most recent income and expenses, according to the city’s Department of Finance.

in short, turning around the office market would require a return to the corporate norm of cubicles and commutes. And that will only happen if and when companies determine that the current post-pandemic reality is bad for worker productivity. 

“It would take a near consensus that hybrid and remote policies are resulting in uniformly negative outcomes for companies,” Van Nieuwerburgh said. 

While the outlook for office space is overall gloomy, more commercial real estate investors are considering and investing in converting their buildings into other uses—particularly office-to-residential projects. Reusing office space for multifamily units could help to ease the undersupply of an estimated 2 million to six million housing units, according to Morgan Stanley.

While there are more than 200 office-to-residential projects underway in the U.S., according to a study released by Deloitte in July, there’s much more that could be done.

“If you look at what has been converted since 2016 and what is even planned to be converted through 2025, that’s only 90 million square feet,” Whelan previously told Fortune. “So when I say that the conversions that have happened and that are underway are really only a drop in the bucket with the vacancy that’s out there, that’s what I mean.”

Van Nieuwerburgh, however, says there’s a limit to conversions because only about 10% of office buildings in downtown areas with “substantial vacancy” may be viable for such projects. This expands even beyond residential usage to include mixed-use space, medical offices, student dorms, child care, and even pickleball courts. 

“Not all conversion projects make economic sense,” he warned.