The pandemic has had a lasting impact on real estate. Office attendance is 30% below what it was pre-pandemic, according to the consulting firm McKinsey. In other words, the trend of remote work has stuck. This has big implications for the future of office properties — with so many of them already languishing, sitting there empty — and the people and places nearby.

The McKinsey Global Institute looked into the state of commercial real estate and published its findings in a new report on how cities are changing. It’s called “Empty spaces and hybrid places.” Aditya Sanghvi, a senior partner at McKinsey and a co-author of the report, joined “Marketplace Morning Report” host David Brancaccio to discuss his observations. The following is an edited transcript of their conversation.

David Brancaccio: So I guess it’s not just me when I walk through Midtown East and it just seems quieter in those office buildings.

Aditya Sanghvi: Yeah, it’s not just you. The pandemic has truly changed the fabric of urban real estate, and it really does start with the office. The office is at the epicenter of the seismic shifts that have happened. And it’s because the office was really a place that many of us had to go to. And because of the pandemic and the technology adoption that happened during the pandemic, now the office has to be a place that we want to go to. The reality is that most of our office spaces are not set up well to be a place that I want to go to. And as a result, you’re seeing a lot less people.

Brancaccio: I mean, you’re not going to find much child care if you go in to the office. That’s a big issue for people. And also, unless you live right nearby, there’s going to be a commute.

Sanghvi: Yeah, exactly. And I think the commute in particular has been one of the main reasons why people are not coming to the office. And the reality is that the experience at the office is not always better than the experience at home. So even if I did take the pain of making the commute, am I going somewhere where I feel more productive, more joyful, is more convenient than being at home? The answer for many knowledge workers is no. And that’s why so many folks are staying at home. And we’re at a level of only about 3.5 days per week in which people are coming in.

Brancaccio: So companies must be reevaluating their relationship with commercial real estate. I mean, some are stuck with leases, not much they can do, but others are reevaluating.

Sanghvi: I think almost every company is, and these are both the companies that occupy office space, but then also retailers who are having physical stores, and they think very differently about where their stores should be. And then it includes industrial companies thinking about the supply chain that works.

Really the pandemic has changed everything about the fabric of the demand. But, on the office side, in particular, most of our clients are really focused on how do I rightsize how much space I have? So only take the space that I really need for the tenants that are coming in, but make that space even better of an experience than it was before the pandemic because then maybe I can get the people that I want to come in, in the moments that I want them to come in, to work with the people I want them to work with. And that’s been really the focus that companies have had. But to your point, they don’t need as much space as they had before. And certainly a 10-year lease is very difficult. Because if I barely know how much space I need in one year, how am I gonna know how much space I need in 10 years?

Brancaccio: What are companies thinking about making the workplace a little more attractive? I mean, going all Silicon Valley and bringing out foosball tables and free potato chips?

Sanghvi: Well, I think really what companies are trying to do are trying to be, first and foremost, thoughtful about what are the activities and the types of roles of the people that I want in the office. There are jobs that one can do even better when working from home and are more productive. Then there are other things in which it might be better to be in person and in the office. So a big focus that companies are trying to have are what are the moments that matter in which being together really makes a difference? And how do I really encourage and maybe require people to come in for those moments that matter? And then give the flexibility for all the moments that don’t matter as much.

Brancaccio: I know. I went in the other Monday and I was all alone, did not see a soul in our place that day, yet had to commute in, commute out. It makes you rethink that situation. What’s your sense from your data about strains to the commercial real estate industry because of these ongoing patterns?

Sanghvi: Well, as we looked at nine cities really in focus, what we tried to do is to project out to 2030 and see, what does the demand for office space look like in each of these nine cities? And, overall, you know, in the median city, it’s about 13% lower in 2030 than it was pre-pandemic. And in our most effective city, it’s about 38% lower in our severe scenario.

If you have lower office attendance, that means that companies are then needing to take less space. You will have more vacancy, and of course that will then impact the real estate industry’s valuation. So we think values could fall between 26%, in a moderate scenario, to 42% in severe scenario. And in just these nine cities, we’re talking about $800 billion in potential value of office real estate space just from that.

Brancaccio: It’s interesting. I was looking into banks with the biggest exposure to this. It’s not the nationwide household names, generally. It’s smaller, more midsize outfits that have a lot of this commercial real estate on the books.

Sanghvi: Yeah, that’s right. Regional banks and also the local community banks tend to have a greater share of real estate amongst their overall loan portfolio. And many of them are starting to see defaults pick up. And it’s our view that defaults are likely to increase even more. And with rising interest rates, they have to ask themselves the question of, “Is real estate really the best place to put money into?” And what that’s going to lead to is just a lot less capital in the system, exactly at a point in which capital is needed to actually make many of these offices a lot more attractive of a place for people to go to, where money is needed to take advantage of the opportunity and prices, location of office assets that might be undervalued. So the capital markets will likely be more frozen because of the challenges that these banks will have.

Brancaccio: It’s a really interesting point. Well, I suppose we could also look on the flip side, right? Less traffic, more parking possibly, and maybe, if some of this commercial space could be converted, something that might help ease the affordable housing crunch.

Sanghvi: Yeah. I think that policymakers and cities have to really think about this question holistically. I mean, if you think about the last couple of decades, everybody has talked about a lack of space as being one of the hardest problems that confronted major cities and policymakers. But now there’s space. And the question is, what do you do with that space?

It’s fascinating that when you look at a lot of the data, the places that have continued to have good office attendance are the ones that typically are more mixed-use in nature. So if you go to a central business district, and all there is is office towers, that’s not really a vibrant place that you want to go to.

But if you go to a place that’s downtown, that has a great mix of restaurants and retail and entertainment, and has a lot of people living there and it feels like a place that everyone’s in, that might be a place that you more want to go to from an office perspective. So, actually, creating more of these mixed-use neighborhoods and districts is a great opportunity that cities have, but they have to think about that kind of holistically.

And, to your point, one of the other challenges in many of these city locations is that housing is too expensive, and we have way too little housing in the country at affordable levels for what we need. And this might be an opportunity to take more space and to actually use that for affordable housing. Now, it is unlikely that you can just do conversions of a lot of the office space that’s out there because even if you did that across the board, it wouldn’t add up to that much housing. And the floor plates of offices are often much bigger than what you would need in residential. But still, there is an opportunity to think differently about zoning and to think differently about that space to get more affordable housing into the system, which we desperately need.