In this episode of the REconomy Podcast™ from First American, Chief Economist Mark Fleming and Deputy Chief Economist Odeta Kushi explain how remote work contributed to the pandemic-era real estate boom and why the prevalence of remote work may still sway residential and commercial real estate demand.

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Listen to the REconomy Podcast™ Episode 48:

“First, the frenzy of the pandemic-era housing market that drove prices so high is a historic exception, but one that is actually supported by the fundamentals of that migrating behavior. Albeit these are somewhat unique fundamentals because it was a pandemic after all. And, second, remote work will remain an important factor shaping house price growth in the near future.– Mark Fleming, chief economist at First American

Transcript:

Odeta Kushi - Hello, and welcome to episode 48 of the REconomy podcast, where we discuss economic issues that impact real estate, housing and affordability. I am Odeta Kushi, deputy chief economist at First American and here with me is Mark Fleming, chief economist at First American. Hey Mark, just out of curiosity, where are you working from today?

Mark Fleming - Hi, Odeta. Um, as with most days when I'm not traveling, I'm working from home, aren't you?

Odeta Kushi - I sure am, though I have been going into the office here and there. You cannot beat our office view.

Mark Fleming - Yes, that's actually true. Being in the heart of Washington, D.C. does have its perks. But I'm confused. Why do you ask?

Odeta Kushi - Well, I asked because we're not alone in working from home. New data released last week by the U.S. Census Bureau shows that, nationally, the number of people working remotely increased in 2021, to almost 18%, from 5.7% in 2019. And there was an even earlier analysis, which showed that 45% of full-time workers were working from home at least some of the time in September 2021, with most anticipating remote work to continue for the rest of the year and beyond. And, can you guess which state, or state equivalent, has the highest share of work from home in 2021? According to that census analysis?

Mark Fleming - Well, for those of us who live here in the DC metro area, you kind of gave it away a little bit with state. I know, I know. I'm gonna go with Washington, D.C.

Odeta Kushi - Oh, great, guess. You are correct. Nearly half, 48.3% to be precise, of workers in the District of Columbia worked from home, the highest percentage of home-based workers among states and state equivalents in 2021. So how would you guess?

Mark Fleming - Well, apart from the state equivalency comment, there's, you know, a small sample, me, you know, sample size of one. And, of course, as an economist, we would all want to interpolate based upon a sample size of me, and a little bit of confirmation bias on my own. I assumed people like you and I were mostly working remotely in D.C. And then I noticed the lack of traffic driving into the city over the pandemic. It was beautiful. And voila, my decision.

Odeta Kushi - All right, well, I guess your confirmation bias worked that time.

Mark Fleming - Well, sometimes my priors...Get it? Confirmation bias. Priors. No?

Odeta Kushi - Nothing like some bad economist humor to start our REconomy episode. All right, getting back to business, in addition to D.C., states with the highest percentage of home-based workers were Washington at 24%, Maryland, also at 24%, And Colorado, basically 24%, and Massachusetts, also 24%. 2021 marked the highest number and percentage of people working from home recorded since the ACS began to record it in 2005.

Mark Fleming - Odeta, where did all of the significant digits that you like to report go?

Odeta Kushi - I was trying to round up because they weren't all 24. It was like 24.2 and 23.7, so.

Mark Fleming - Multiple, even at the first digit being the same, but we digress. I'm not surprised the pandemic has untethered many workers from their office buildings, and it has strong implications for real estate, both residential and commercial in this case.

Odeta Kushi - That's right. Now we all know, and if you don't, then you haven't listened to our podcast before, that the record-breaking annual house price appreciation nationwide and across markets in 2021, and early this year, reached 21% year over year, and that was due to a severe supply and demand imbalance. Pandemic-era dynamics only exacerbated this divide and further contributed to price growth. Now, if only someone had figured out just how much the pandemic and the shift to work from home has contributed to house price growth.

Mark Fleming - Yes, that house price growth that everyone is asking the questions about. What's happening to house price growth? If only someone...if only...Oh, but today's your lucky day, Odeta, because someone has. A recent working paper released by the National Bureau of Economic Research on remote work and housing demand found that the shift to remote work accounted for at least half of the 24% increase in house prices between December of 2019 and November of 2021. Half of the increase. And that's even after controlling for things like migration across markets. So the pandemic and working from home has had a significant influence on house prices today.

Odeta Kushi - That's huge, and that the propensity for remote work has had such a large impact on house prices suggests that it will be an important indicator to monitor in the post-pandemic housing market. So, why did this happen?

Mark Fleming - I'm so glad you asked. As the COVID-19 pandemic forced workers to use their homes as their office, as well as their gym, their daycare, their school, their housing preferences shifted. Workers migrated from expensive locations to cheaper ones, both within cities and between cities. And, in addition to migration to more affordable cities, urban city centers lost residents relative to their periphery.

Odeta Kushi - Mark just be honest. Did you buy a peloton during the pandemic?

Mark Fleming - No, no, no, I did not. I did buy all the kit to make my bike into an indoor trainer and I did shift from using our office gym to using that bike at home in my now home office/gym. Like many other American households, I contributed to a significant increase in goods demanded for consumption, quote, in the home in those early days of the pandemic.

Odeta Kushi - And I, well, I went from buying my sandwich from the coffee shop next to the office to buying a bagel at the bagel place by my house.

Mark Fleming - Aka, demanding services closer to home, instead of the office. We'll get back to that.

Odeta Kushi - We will. But back to the paper we go. The paper found that the shift towards remote work also increased aggregate demand for housing, rather than simply reshuffling it across the country, people sought out larger and higher quality housing. The result was an increase in both house prices and rents in locations where the share of remote workers was higher, as well as a decrease in commercial rents consistent with reduced demand for office space.

Mark Fleming - That's right. There are two important implications of this research. First, the frenzy of the pandemic-era housing market that drove prices so high is a historic exception, but one that is actually supported by the fundamentals of that migrating behavior. Albeit these are somewhat unique fundamentals because it was a pandemic after all. And, second, remote work will remain an important factor shaping house price growth in the near future.

Odeta Kushi - Interestingly, the markets with the highest remote work share, large coastal markets like San Francisco and again, Washington D.C., have had some of the slowest house price appreciation rates compared to other top markets. So, without the rise in remote work, it's possible these markets would have experienced even slower appreciation.

Mark Fleming - That's right. And there have been other interesting studies about the effects of remote work on cities as well. We'll link the studies we link to the studies in the transcript of this episode, which you can find on our blog at firstam.com/economics. One study found that retail spending and housing demand shifts from city centers to the periphery in what has been dubbed the quote, donut effect.

Odeta Kushi - Or in my case, a bagel effect. Really? Nothing. No laughs. That's it.

Mark Fleming - I'm trying to hold back here, I'm still focused on powdered sugar, honestly.

Odeta Kushi - Exactly, well, you know, the center of the city is the hole of the bagel with a ring around it where everyone lives, works, eats, plays. Does everything, essentially.

Mark Fleming - Exactly. And it's estimated that approximately 15% of the population and business establishments have moved from central business districts to those suburbs where everyone is living, working, playing and doing everything. That shift to the suburbs is accompanied by reduced demand for dense living.

Odeta Kushi - Which brings me to yet another study which found that 20% of full workdays will be supplied from home after the pandemic ends compared with 5% before. The same research indicates the shift to work from home will directly reduce spending in major city centers by at least five to 10% relative to the pre-pandemic era. Of course, as we just discussed with my bagel example, the spending will not entirely disappear, but rather shift from urban centers, where the office is, to where people are working from, which over the pandemic was increasingly suburbs and exurbs. And, if you want a deep dive into what we've been calling the second coming of suburbia, you can check out episode 14 of the podcast.

Mark Fleming - And you just touched on the impact on commercial real estate. Let's talk about that a little bit more. Work from home means we're working less from the office. We were just saying that. While national physical occupancy, according to Kastle Systems card-swipe data, increased after Labor Day to 47.5% -- nice significant digit there.

Odeta Kushi - I appreciate that, thank you.

Mark Fleming - It still remains far below the pre-pandemic occupancy rates, obviously.

Odeta Kushi - There was a shift in office demand to suburbs over the pandemic, which makes sense, it's following the people. So, our Econ team uses that work-from-home data from the U.S. Census Bureau that we mentioned earlier, to analyze how office leasing activity has changed in metros with greater increases in remote work. And we found?

Mark Fleming - Surprise, surprise, generally, that cities with larger increases in remote work share tended to have higher availability rates, a measure of all space currently listed, vacant, subleased and for sale, in those markets.

Odeta Kushi - But what was more surprising was that a number of cities bucked this trend. This is especially true for major Texas metros, where physical occupancy rates have consistently been higher than others. Despite relatively small increases in the work from home share. Houston and Dallas have the highest availability rates among the top 50 metropolitan areas. This implies that even cities with high return-to-office rates are prone to leasing headwinds. So, what is the implication here for office real estate?

Mark Fleming - Before we add to that, I just have to say it seems like the classic economist joke, right? On the one hand and on the other hand...It's never quite so straightforward. Yeah. But we can tell that things will likely get worse before getting better for the office sector. Leases covering over 200 million square feet of office space are forecasted to expire each year over the next three years. And, during that time, low interest rate loans originated over the last two years will begin maturing and -- let's go out on a limb here -- likely in a higher rate environment. And those underperforming office assets will struggle to refinance at these higher interest rates that we're sure to have in the next couple of years, especially if they're unable to lease that vacant space to new tenants in the first place.

Odeta Kushi - And lenders, who are already tightening lending standards for most commercial real estate loans, will increasingly face the difficult decision of rolling over debt on properties with less certain cash flows and at higher interest rates, or restructuring existing loans, so that borrowers can continue to service them, or taking impairment losses. The difficult choices ahead for lenders is likely why the Federal Reserve recently released new guidance on commercial real estate loan accommodations. Its first update to the policy since 2009. And, while the Fed's policy guidance is intended for all commercial real estate lenders, it is office lenders that are in the most precarious position.

Mark Fleming - Right. Lending first requires leasing and it remains unclear how successful offices will be in renewing leases over the next few years due to the work-from-home transition that's happened with such a large proportion of people doing it.

Odeta Kushi - Right. So, the takeaway from this episode is that work from home has strong implications for real estate, the pandemic-driven shift to more remote work changed where we live, where we consume and where we work. Even in a post-pandemic world, residential and commercial real estate demand will continue to respond to the trends in remote work. All right, well, that's it for today. Thank you for joining us on this episode of the REconomy podcast. If you have an economics-related question you'd like us to feature on a future episode, you can email us at economics@firstam.com. We love to hear from our listeners. And, as economists, you know, we love our metrics and data. So, if you enjoy listening to the podcast, please make sure to give us a rating on your favorite platform. And, as always, if you can't wait for the next episode, you can follow us on Twitter. It's @OdetaKushi for me and @MFlemingEcon for Mark. Until next time.

This transcript has been edited for clarity.