US embrace of remote working empties offices, weighs on banks

The surge in remote work adoption across the United States has led to a significant exodus from traditional office spaces, raising concerns about plummeting property values and potential loan losses for building owners, consequently exerting pressure on smaller financial institutions.

Federal Reserve Chair Jerome Powell cautioned on Thursday that while the fallout might not directly affect major banks, there could be repercussions for smaller ones as the trend of emptying offices persists, especially in major metropolitan areas like San Francisco, Washington, and New York.

According to a December report from credit agency Fitch Ratings, office vacancy rates nationwide surged from 9.5 percent in 2019 to 13.5 percent in 2023, with projections indicating a potential increase to 16.6 percent by the end of the following year. Powell highlighted the underpopulated nature of downtown office districts in many cities during a Congressional hearing this week.

The commercial real estate sector has been particularly hard hit by this shift, experiencing a staggering one-third decrease in value. With $737 billion in office property mortgages, a quarter of which are set to mature this year, the Mortgage Bankers Association faces the challenge of refinancing loans in cities with high vacancy rates and depressed valuations, compounded by the highest interest rates in over two decades.

EY chief economist Gregory Daco warned of a potential “chain reaction” scenario where banks could face increased default risks from borrowers, resulting in capital stress. While National Economic Advisor Lael Brainard acknowledged the stress within the commercial real estate sector, she downplayed broader implications for the financial system, emphasizing the narrow scope of affected properties.

Smaller banks are particularly vulnerable to absorbing losses from defaulted loans, potentially triggering a domino effect that could reverberate through the financial sector. Powell assured that the Federal Reserve is actively engaging with institutions facing heightened risks and monitoring the situation closely.

The broader economic impact extends beyond banking institutions, with retirement funds and insurance companies potentially facing losses from exposure to commercial real estate. Fed Governor Michelle Bowman underscored the urgency of encouraging a return to office work to mitigate the prolonged repercussions of the current trend.