As the economic recovery begins and COVID-19 vaccines become readily available, businesses and real estate professionals alike are working to determine their post-pandemic steps in the office market.
The 2020 numbers are bleak. A recent report from Cushman & Wakefield Chief Economist Kevin Thorpe noted that the office sector experienced 104 million sf of negative absorption in 2020 — more severe than the impact of the recession of 2008. In the wake of COVID-19, 1.15 million office-using jobs were eliminated, with office vacancy rising from 12.9 percent to 15.5 percent by the end of 2020.
“Office leases are long term,” says Dan Spiegel, vice president and managing director for Coldwell Banker Commercial. “We’re in the discovery phase of what the future of office will be and what its impact on office property owners will be. In the short term, the pandemic has driven employees home. The question is, how comfortable will firms be keeping some of those people home permanently versus the value of having them back in the office? Some firms are subleasing space because, in the near term, they’re not seeing the need for employees to come back to the office. Other firms are taking space because they’ve come up for renewal, and they have to make a decision. We’re still in the early stages of understanding what the long-term impact will be.”
More than anything, the watchword appears to be flexibility. The first key will be how companies decide to bring workforces back to the office. The Cushman & Wakefield report notes several big-picture factors that will affect this return, including the trajectory of the virus, the speed at which vaccines are rolled out, how soon schools reopen, and government policies. But companies and employees will also have to examine the necessity of coming back to the office after a year of figuring out how to work remotely. Working at home, of course, is nothing new, but, Spiegel says, “the pandemic has accelerated many trends in the workplace that were already underway.”
“We’re entering a near-term era of workplace flexibility,” he adds. “Companies are not yet sure of what they’re losing by not having people in the office, so they don’t know if they want to give up the office all together. Some people are comfortable working from home; others are challenged balancing family priorities and other things.”
“There’s still a wide unknown out there,” says Scott Homa, senior vice president and director of U.S. office research for JLL. “Before the pandemic, 10 percent of who you’d typically think of as an office employee worked principally from home. We think that share is certainly going to increase, but it’s likely to increase more within a hybrid format,” where employees may come into the office only a few days a week. The challenge in moving in that direction, though, he says, will be managing the capacity of the space and accommodating work schedules, safety protocols, and other factors.
Another factor, particularly in high-density urban areas, is the commute. Homa notes that it may be a while before people are comfortable getting on crowded trains or buses. Add to that the commuting time itself — a recent PwC/Urban Land Institute study calculated an average of 227 hours a year saved by not commuting. The savings, according to the study titled Emerging Trends in Real Estate, “has been well received by many. That is certainly not surprising, since it is the equivalent of 28 days that could be dedicated to work or leisure.”
A large part of companies’ reluctance to invest too deeply in a remote format is the nature of the office itself. “The purpose of the office in many ways is not just providing an environment for people to do individual tasks, but more so around the collaboration and innovation that the physical space can be used to facilitate,” says Homa. “People want to be together to collaborate, problem-solve, and meet with clients.”
Offices provide other functions as well. “In-person workplaces are critical for company culture, innovation, [and] onboarding for new employees,” according to Emerging Trends in Real Estate. Younger or new employees may prefer the office environment, which could provide more opportunities for learning and making business and social connections. In many cases, in-person workplaces can offer more resources and tools to help them be productive. The report also points out that working remotely could present challenges to some employees because of space or technology issues at home.
However companies choose to bring back workers, offices themselves will face physical changes. “We’re likely to see office layouts change, in which there’s some de-densification, in which there’s a reallocation of space from individual workstations to larger, collaborative meeting spaces,” says Homa.
The question is, how comfortable will firms be keeping some of those people home permanently versus the value of having them back in the office?
The PwC/Urban Land Institute report notes that companies had been reducing office space before COVID-19 by shrinking the space per worker through bench seating and an increased use of common areas. This trend, though, will likely reverse — 63 percent of the respondents said that because of social distancing recommendations, office tenants would now need to increase the square footage per worker.
In the short term, Homa says, offices will also have to offer pandemic-related safety features such as hand-sanitizing stations, social-distancing measures and signage, and touchless technology. Longer term, he says, “the pandemic has provided a renewed focus around health and well-being in general, and specifically indoor air quality. Ventilation, filtration, and air purification are huge issues, whether that means upgrading HVAC equipment, putting higher caliber filters in place, or even changing design specs around projects to provide operable windows or outdoor and terrace space.”
Such improvements will come at a price; although Emerging Trends notes that because the demand for increased health and safety features has been so accelerated, the market is still sorting out the requirements and costs. The report quotes one developer who estimated costs “somewhere around 1 to 2 percent of our total development budget.” At the same time, such upgrades could end up being a competitive feature in the marketplace. The report quotes one executive who said, “Smart building owners are going to want to say our building has the cleanest air quality.”
Coworking spaces help companies that might be reluctant to lease space because they’re not sure of their workers’ needs.
Another competitive feature that went dormant in the pandemic but will likely return? The trend toward high-end amenities, such as in-house gyms, coffee bars, and posh cafeterias will pick up where it left off before the pandemic. “Just as restaurants are opening up, these help create a desirable environment for workers,” says Spiegel. “Presuming they can accommodate public health measures, I think those places will stay. We just want them to be safe.”
The post-pandemic work environment may give a boost to coworking spaces. “I think what was originally perceived to be a high-risk moment to coworking may be the salvation once the pandemic is addressed,” Spiegel says. “They present a workplace solution that’s flexible, because it’s not long-term, and ubiquitous, because there are so many locations.” Coworking spaces, he says, help companies that might be reluctant to lease space because they’re not sure of their workers’ needs. The flexible model lets them wait and see how the marketplace will shake out.
In fact, a recent report from Colliers International predicts “significant growth” of flexible workspace outside of CBDs. It also says the “flexible workspace supply outside of downtown locations is already causing a supply pinch in some markets.” The report, Flex Forward: What’s Next for Flex in 2021, adds that non-CBD flexible space will increase dramatically this year, with supply coming from existing operators and new entrants as well as “repositioned retail and hotel assets.”
City vs. Suburbs
As the pandemic progressed through 2020, many city-dwellers looked to relocate to suburban and even exurban areas, both to escape densely packed urban areas and have more space as they started working from home. Will offices follow?
“There’s a tremendous amount of talk about the urban-to-suburban migration, but the larger issue is region to region,” says Homa, “and all of that isn’t completely new and driven by the pandemic.” Companies relocate for such factors as climate, the tax environment, and the availability and cost of labor. He points to states like Texas, Florida, and other lower-cost markets that started to experience growth even before 2020. “But in terms of tenants making a 10- or 15-year commitment to the suburbs rather than the city, that’s not something we’re seeing.”
Spiegel, too, says he’s seen “a handful of stories about companies consolidating operations in the suburbs, but I don’t think it’s yet to be declared a trend.” Still, he says, “now that people have worked at home for close to a year, are they going to prefer to be closer to their home if they’re suburban residents? Or will we go back to what’s been the trend of the last five years [with] similar workers congregating in the CBD?” In the short term, he speculates that companies could offer a hub-and-spoke model or alternative work locations for suburbanites who have fled the city or who aren’t yet comfortable returning to mass transit.
As they navigate the post-pandemic office landscape, real estate professionals will likely encounter a host of unfamiliar challenges.
Cushman & Wakefield data show that cities are still making a strong showing in the office market. While the firm’s sample size was smaller for 2020, it reports that CBDs account for 30 to 40 percent of leases in a typical year — a figure that didn’t change in 2020. In addition, Cushman & Wakefield says it found no evidence that many businesses were leaving big cities for smaller ones. About a third of all U.S. office leasing occurs in gateway cities in a typical year, and that figure was similar in 2020 at 32 percent.
As companies reassessed their space strategy in 2020, the subleasing market surged. JLL research shows that the sublease market expanded by nearly 47.6 million sf since the pandemic began, bringing the total to 141.5 million sf. The largest industry sectors giving back space were tech companies, who subleased 5.8 million sf, and finance with 2.9 million sf. By February 2021, though, Homa says “one encouraging sign has been an uptick in tour activity among those sublease spaces that have been put on the market, as well as a handful of executed deals and a deceleration of blocks put on the market.”
It could take time for rents to show a decline. A February report from Cushman & Wakefield noted that historically, national office asking rents don’t decline until four quarters after vacancy begins to increase. In fact, the report points out, during the last two recessions, no U.S. markets hit their overall rent trough within a year. There have been exceptions this time around; Colliers 4Q2020 Office Market Outlook reports that the largest 4Q declines in major CBD markets were San Francisco (-9.8 percent), Austin (-3.7 percent), and Manhattan (-2.8 percent). And a February Moody’s Analytics forecast predicted a 7.5 percent decline in 2021 and added, “We do not expect average effective office rents to reach their pre-pandemic levels until 2026.”
As property is leased, “landlords have been reluctant to move face rates,” says Homa. “But we have seen on a net effective basis, inclusive of concession packages, some shifts that are more tenant favorable — largely through things like free rent and tenant improvement allowances. But landlords have had that bias to keep face rates fairly steady.” Leases did get shorter during 2020. JLL figures show an average term of nine years during the first quarter and seven years by 4Q2020, reflecting, perhaps, some lingering uncertainty about longer commitments.
As they navigate the post-pandemic office landscape, real estate professionals will likely encounter a host of unfamiliar challenges. To manage the road ahead, Spiegel recommends a basic tried-and-true approach.
“Commercial real estate professionals are best equipped to handle market changes when they ask questions and understand the needs of their clients,” he says. “Ask about workplace issues: Is the workforce happy and engaged? The best professionals are those who ask probing questions about how the real estate asset is helping achieve the goals of the tenant and then listen carefully. Ask not just about near-term but long-term changes to the client’s business strategy or challenges that they can address through real estate.”