Hybrid work has roiled the real estate market—and it’s here to stay, according to new research from the McKinsey Global Institute. On this episode of The McKinsey Podcast, McKinsey senior partners Aditya Sanghvi and Jonathan Woetzel chat with global editorial director Lucia Rahilly about how the persistence of the pivot to working from home has transformed the places we work, live, shop, and socialize—and about the unique opportunity hybrid presents to rethink real estate for our changing future.
Also on this edition, demographer Jennifer Sciubba talks about our misconceptions around migration and population trends, from our Author Talks series.
This transcript has been edited for clarity and length.
The McKinsey Podcast is hosted by Roberta Fusaro and Lucia Rahilly.
Hybrid is here to stay
Lucia Rahilly: Let’s start with some context. The COVID-19 pandemic upended lives in myriad ways. And perhaps one of the most lasting has been hybrid work. Will hybrid persist?
Aditya Sanghvi: What’s clear to us is that hybrid is here to stay. There are three reasons for that confidence. First, the attendance rate we’ve seen has really stabilized, and it has stabilized for over a year now. Second, actual attendance aligns quite closely with what workers want and expect from their employers. Third, there’s a substantial number of knowledge workers who would rather resign or accept a pay cut than come in more often, and many of those folks are the executives in charge of making those decisions.
Lucia Rahilly: So practically speaking, what does protracted work from home mean for downtown districts or other areas with a high density of office buildings? Has hybrid work had ripple effects on those neighborhoods?
Jonathan Woetzel: Yes, it definitely has. If we look at neighborhoods which were very office-dominated, the first main impact is simply fewer people in those offices. That, in turn, means fewer people on those streets, fewer people in the shops or just anywhere in the neighborhood. That, combined with the rise of online commerce, is creating a big challenge for those downtown retail spaces and public spaces in those office-intensive areas.
The other obvious impact is on residential usage. As people are closer to home, we’re seeing demand for those homes rise. And then around those homes there’s a minor resurgence of retail. So we see the shopping and commerce patterns shifting as the people shift.
Lucia Rahilly: What does the data say on the flight to the suburbs that was so visible during the early stages of the pandemic? Has that persisted as well?
Aditya Sanghvi: Yes, during the pandemic there was an out-migration from urban cores. And in the nine cities we studied, some lost up to 7 percent of their people, which is really significant. Those people have not come back. And while the rate of out-migration in those urban cores has been lower, it has continued to be negative. This means that people are moving more to the suburbs than the urban core. Basically, people left during the pandemic, they’re not coming back, and the urban cores continue to see relative out-migration versus the suburbs around them.
Where’s worst hit—and why
Lucia Rahilly: Is this a global phenomenon? Which cities have been hardest hit by protracted hybrid work?
Jonathan Woetzel: Of the cities we studied, San Francisco is clearly the hardest-hit city. First of all, it has a relatively densely built urban core. Second, it’s office-oriented to a much greater degree than many other urban cores. Third, the access to public transport relative to some cities is not as strong.
Aditya Sanghvi: San Francisco actually had a double whammy because in terms of business mix, it has a higher share of technology jobs, and it has talent that had the power to assert what they would accept. In an urban structure, San Francisco is office-dense, with 30 percent of space dedicated to offices. Home prices are five times the national average. And they have a very high share of inbound commuters relative to other cities. So on both of those impacts they were worse off, and that’s why you saw the drop-off that San Francisco did see.
Jonathan Woetzel: On the other hand, Tokyo has pretty much the opposite of all of that. It has suffered relatively less impact because of the great public transport and mixed-use areas.
Lucia Rahilly: Tell us more about the constellation of factors that allow hybrid trends to affect one city more than another.
Aditya Sanghvi: In our research we simplified it down to two things. One is business mix: What is the industry mix of the city? What share of workers in the city are employed at large firms? Employees at those large firms tend to come into the office a little bit less than those at smaller firms. There are also differences in the cultural acceptance of remote work.
The second focus was urban structure. One of the most important factors concerns how often people commute to work by coming into the city, versus actually living in the city itself. Another factor is whether the urban center is office-dense or has a lot of green space and residential housing. And also whether housing is expensive. So those two factors, business mix and urban structure, are really what seem to drive the differences.
Lucia Rahilly: You modeled a range of future scenarios as part of this research. What do we expect demand for office space to look like in the years to come, based on the nine cities you studied?
Aditya Sanghvi: In a moderate scenario, we found that office demand in 2030 could be 13 percent lower in the median city that we studied. What’s fascinating is that values could be 26 percent lower in our moderate scenario and up to 42 percent lower in our severe scenario. In just these nine cities, that’s $800 billion of potential office real estate value disappearing.
Lucia Rahilly: Remarkable. If demand for office space is falling, does quality become a higher priority?
Aditya Sanghvi: Yes, in many ways, quality becomes everything. For many people, the offices that they experienced prepandemic weren’t more compelling or interesting than working from home. And once childcare was restored and kids could go back to school, people could take care of the elderly. So flexibility remained, even though some of the restrictions of the pandemic went away.
People ask themselves, “Is the office experience I’m going to have today worth the commute that I need to take?” For large portions of our knowledge-worker population, the answer has been “no.” The commute is not worth it, and that’s why people are not coming in to the office.
So, quality becomes everything, but the definition of quality is now more focused on the employee, not the employer. That is a significant change in office real estate, because it’s about, can I get people to want to spend time in the office? That’s what employers care about as well. That’s what drives quality.
Jonathan Woetzel: This shift from supply-centric to demand-centric is going to reshape the environment. Every meeting that you used to have would be either a phone meeting or in person. Now, every meeting has a video conference option. It creates choice for everybody. And that’s going to be reflected in everything, from choices of location to the design of the buildings themselves. It introduces a lot more flexibility, and for the supplier, employer, or developer, it is imperative to use that flexibility.
Retail as a bellwether
Lucia Rahilly: If the demand for office space remains lower than historic norms, how does that affect the future of the retail ecosystem? As you said, retail was arguably faltering prepandemic. How will retail fare in the years to come, according to your scenarios?
Jonathan Woetzel: Retail will become a lot more experiential, which includes community experiences as well as mixed-use. That means a lot of healthcare and a lot of education. If you go look at shopping malls these days, a good 20 percent, 25 percent of it is in those formats, because those are things you really want to do in person. Whereas commodity buys are going to go online. You’re also going to see a lot of interesting developments, particularly around areas which have both residential and retail, around thinking about retail as delivery points.
Aditya Sanghvi: I would add that retail is a really interesting analogy for what might happen in offices. Ten to 15 years ago, shopping happened largely in person. You had to go to a store to get what you wanted. What e-commerce did is create an option to do that from home. What you then saw was a huge separation in quality between the shopping mall centers that attracted people, where families wanted to go on the weekend to spend time with one another, versus the other ones that just allowed people to buy. People stopped going to the places they didn’t need to go to anymore. They bought online, and continued to go to the high-quality places that were actually a great experience.
That’s exactly what’s happening in office spaces now. Now, if I have a low-quality office, I can do the same version of my work at home. I want to go to the places I want to be in. That’s why we think the quality office will continue to do really well, and the low-quality office will do poorly, just like low-quality shopping malls did poorly over the past ten years.
Ripple effects on residential neighborhoods
Lucia Rahilly: Selfishly, I’m interested in what the research yielded on what might happen in the residential markets in these urban cores. As Jonathan knows, I live in New York City, where the cost of real estate is one of three topics on regular rotation at every dinner table. What did the scenarios show?
Jonathan Woetzel: You’re fine if you are a property owner. If you’re a renter, not so much. The demand for residences will increase in every city except for maybe a few of the hardest hit. It’s based somewhat on population growth. In a lot of these megacities or more advanced economies, we are just so far behind in terms of meeting the demand for residential space, including in the urban core, and we’re not going to catch up.
But we do see an ongoing longer-term trend toward rising residential prices. There are changes in the mix. For example, larger homes in the suburbs, and the prices for two- to four-bedroom homes rising a lot more quickly than prices for one-bedroom homes.
That reflects that move outward to say, “OK, I’m going to spend more time at home. I want a bigger home.” But at the same time, we don’t see this as having a dramatic impact on the values of residential housing in any place that we’re talking about. This is largely because of the broader picture around residential: we simply are way behind on building places for people to live.
Aditya Sanghvi: Adding on to what Jonathan said, there’s a huge dispersion across different cities, due in large part to urban structure. A lot of urban cores are downtowns that mostly have office buildings. The value proposition of those downtowns is very challenged right now. Conversely, places that have a great combination of retail experiences, restaurants, residential living, and offices are actually seeing demand potentially go up, because people want to be there.
Lucia Rahilly: I live in a primarily residential neighborhood, and at the beginning of the pandemic we were all terrified that our favorite mom-and-pop stores would go under. But in fact, many of them seemed not just to survive but in some cases thrive, in part because so many of us were working from home and patronizing these neighborhood shops more frequently. Is that what you are talking about?
Jonathan Woetzel: Yes, absolutely. The residential mixed-use neighborhood is alive and thriving. Taking back the sidewalks for outdoor dining, for example, was a response there. And cities supported that. People have, by and large, kept innovations from the pandemic that proved successful. That’s a tribute to what people want: this notion of a walkable, livable environment.
Now, not every place is like that. I would caution that if you were living in South Los Angeles, this was not a good thing for you, because you don’t have those amenities in your neighborhood. And it is a food desert.
So, if anything, the pandemic has accentuated the differences at a neighborhood level, and the work-from-home paradigm is going to do the same. We’ll have some people clustered in very nice neighborhoods, and then they will periodically commute to their offices. Service personnel will cluster around the “estates” in these farther-off communities. That’s a caricature of what this looks like, but it does show what people want: they want this mixed-use, livable environment.
Aditya Sanghvi: The neighborhoods that are performing better are the ones that are pedestrian-friendly, that have great green spaces, and have a mix of office, retail, and experiences. They’re sort of an ecosystem of everything that one might want in their life all sort of in one place.
Jonathan Woetzel: I would just add that transit connection is an important aspect of where you will see the possibility for demand. Great transit connections create great flexibility.
Rethinking the office
Lucia Rahilly: It sounds like there’s some risk that these megacities or superstar cities may lose a little bit of their luster. Is that correct in certain neighborhoods? Is that a real risk?
Jonathan Woetzel: Definitely. Let’s not beat around the bush. There’s clearly going to be a reconsideration of the development model. There’ll be a real slowdown in transactions, coupled, of course, with the interest rate environment. We’ve seen a pause, particularly in commercial real estate activity, as people try to rethink what actually is going to be the market rate environment going forward, and how should they reimagine the purpose of these buildings. So you have it at the market level, a district or neighborhood level, and at the building level. Finally, within the building, in an environment where you have to appeal to the employee, there are some spaces that are simply not fit for purpose.
Aditya Sanghvi: Just to add on to the fit-for-purpose part: if the office wants to thrive, there’s a world where it absolutely can. It just has to be completely reimagined. I mean, the office that we have is really designed around the concept of being a place where I have to be. Many offices are cube farms that are just not enjoyable.
These products could also be better designed for employers. Most office leases—and it depends on each country—can be between five and ten years. Most companies have no idea how much space they need in two years, let alone ten years. Why do they need to sign a lease for ten years? That’s really just about how the real estate industry works and how valuations are done, and that has to change.
Jonathan Woetzel: Just to give one example: I’m looking at a bunch of recently built office buildings. It’s questionable what you do with them because of the downgrading of office demand. As a use case, we’ve asked ourselves whether we can convert them to residential. If you look at a recently built office building, it’s got a huge floor plate. If you did residential in this thing, everything inside the first three meters is going to be darkness. So, it’s very difficult and expensive to convert these big blocks.
So you start thinking about what else could you do with that interior space, if not a cube farm. There are some options. First of all: gyms. But then you have to reckon with whether you can have a 28-story interior gym. That’s quite a lot of gym space. Maybe healthcare is an option, because it requires privacy. Those interior spaces could accommodate private experiences. Maybe education, or musical experiences. So there are lots of interesting innovations to be thought of for these buildings, which are built for 50-year life spans. That’s also where I think those long-term leases came from. But now they have to be repurposed for a different customer set and different use.
Aditya Sanghvi: Even in the office buildings themselves, we have to reimagine the product that we’re giving to the tenant. Imagine that I went to go buy a car, and basically what they sold me was the shell of the car, but the car didn’t drive. That’s basically what office space is today. People will say, “Here’s a canvas of space that you can use however you want,” but the problem is that most companies and organizations don’t know how to use the space in a hybrid work environment.
So, one of the really interesting changes that needs to happen is that real estate companies need to become experts and provide solutions for the tenants. They need to give them a “car” that works really well, where they know from experience with other tenants that they’ll want that product. That’s a radical shift in the industry that could allow a lot of the current office space to still be used as office space.
The science of successful space
Lucia Rahilly: What’s the thinking around what should happen at that floor level to make a really hospitable, attractive office space for employees?
Aditya Sanghvi: These office products need to have hospitality. There need to be people on the floors who are well trained in providing delightful food and beverage experiences, helping people find things, and making it more joyful and more convenient for the people who come in.
And then, probably most disruptive, we have to take the office and make it not just art, but bring a science to it. There have been so many designs over time in ways that people run their office space, and no one really has any idea if that’s leading to better outcomes for employees or for employers.
One of the ways that we’re working with clients these days is to actually measure and say, “Here is the productivity, the engagement, of all the employees, and here are their work patterns.” And then you can start to say things like, “The people who join in this type of role and with this type of frequency actually are getting better engagement and better productivity than people who are not.” It’s far better to actually make it a science, and then to continue to get better and better productivity and employee experience from the space over time.
Jonathan Woetzel: Most business cases for developing hospitality and retail spaces in buildings have not accounted for people’s needs. I don’t think anybody in most hospitality industries actually knows where the customer is coming from, for one thing. Nor do they know what is the customer’s relative need for community, sustainability, or what kinds of things boost their productivity.
There’s a need to turn on the lights and understand what influences people. Not on the factory floor but in a communal work environment. When do they need privacy? When do they need sharing? What kinds of information do they exchange? What kinds of information do they not want to exchange? These are things that we are now basically live-testing in buildings. I think that providers and operators that use those data can be much more efficient. That’ll give them a cost advantage, because they will avoid providing the things that nobody cares about.
Lucia Rahilly: Jonathan, you mentioned the challenge of converting some of these buildings. Can you give an example of successful mixed-use development that might be in play?
Jonathan Woetzel: In LA we’ve seen quite a lot of redevelopment in areas that were historically less vibrant. Koreatown comes to mind, and large mixed-use developments like The Grove or even Marina del Rey. Pieces of the city have shown this kind of revitalization.
The challenge is to do it at scale. That’s always a challenge in a place like Los Angeles, which is quite spread out and fragmented. But it is about taking a block-by-block-level view, and then coming up with a model that allows us to efficiently and effectively transfer a whole area, which requires finance but also, more importantly, requires permitting and zoning. This is a moment of renewal where hopefully people see that this is possible and necessary.
An opportunity for renewal
Lucia Rahilly: What about the importance of affordable housing in cities? We’ve talked about neighborhood by neighborhood. Some neighborhoods will remain expensive. There will be neighborhoods on the periphery that may be less expensive. What role does affordable housing play in this discussion?
Aditya Sanghvi: A shortage of affordable housing has long been one of the biggest challenges that many cities have faced. Postpandemic, policy makers can think very differently, because one of the issues they had is that there was often a lack of space that they could think about using for affordable housing. But now there’s space available in many parts of the urban core. Getting the zoning and incentives right would unlock affordable housing and benefit so many across the globe. Jonathan, as one of the world’s foremost thinkers on affordable housing, what would you add to that?
Jonathan Woetzel: This is the crisis of our times. For the vast majority of people in a city, rent is the single biggest piece of their household expenditure. That’s because rent is pretty high.
As Aditya was saying, this is because we’ve had a slowdown in adding to the supply, relative to the demand for this space. This is basic economics 101. So just converting the office to affordable housing is probably not going to make much of a difference, based on the numbers we’ve looked at. But neighborhood reinvention, neighborhood reimagination, and the idea that work can move allows us to think, why isn’t Compton an office center? Why aren’t there employers in Pacoima? What’s holding them back?
That’s the opportunity. Work from home doesn’t create the opportunity by itself. But it does create the moment where you can reconsider the neighborhood. By reconsidering the neighborhood, we can bring a lot more affordability to it, which would be unquestionably a huge source of dynamism for our economies, and, needless to say, for our societies.
Lucia Rahilly: Aditya, Jonathan, thanks so much for joining us today.
Aditya Sanghvi: Thank you.
Jonathan Woetzel: My pleasure.
Roberta Fusaro: Next, from our Author Talks series, demographer Jennifer Sciubba talks about confronting migration and population trends.
Jennifer Sciubba: My book 8 Billion and Counting: How Sex, Death, and Migration Shape Our World is an overview of global demographic trends. A lot of what’s written about population is alarmist in tone, and it really politicizes population issues, which is a real problem because it can prevent us from meaningful reform on important issues. One example of that would be migration to the US. The fear around migration has really infected politics to the point where it’s impossible for Congress to do any reforms to migration that are really needed.
Population trends sound like this really large-scale thing, but at the end of the day, it’s about individual people, just aggregated. What I try to do in the book is take that alarmism out and really give a well-informed social-science view on population trends to hopefully help us move past that.
A lot of people will be surprised to learn how rare migration is these days. The pop quiz that I give when I’m speaking to different audiences is, “What proportion of the world’s population do you think lives outside the country in which they were born?” And answers always overestimate it. Even among expert audiences, they’ll say 50 percent or 20 percent.
But the right answer is just 2 to 4 percent for the past 50 or 60 years. Migrating is rare, and most people stay where they’re born. Recognizing that is really important for several reasons: the message out there that waves of migrants are coming in the future can lead to inaction in the present, because people think, if this is a certainty and there’ll be lots of migrants coming, we don’t have to do a lot.
Here’s an example of that: business leaders who might be hoping to rely on immigrants to fill their workforce in countries where populations are aging and workforces are shrinking might be really surprised and disappointed to see that those waves of migrants aren’t coming. That means that they need to take some action now to shape the workforce that they want in the future. That’s an overestimation of migration, which can be really dangerous.
We know that there are all kinds of forces—climate change would be an example of this—that push people out of rural areas in countries that are not yet highly urbanized. But in the past, urbanization often took place because people were pulled into urban areas because of jobs. Those are two very different things, because when hundreds of thousands or even millions of young men in particular are pushed out of rural areas and into urban areas and they don’t find jobs, a lot of times what that leads to is instability.
One of the coolest things about demography is that any snapshot of a population today tells us a little bit about the future. Trends do change, of course, and I describe a lot of the ways that they change in the book, but they generally follow predictable patterns. Demographics can be really useful for long-term business planning, and also underscore the idea that we have to invest today to shape the future that we want tomorrow.