Offices Face Quantum Shift Post-COVID
The Metamorphosis of the Office Market
by Paul Fiorilla
No sector of commercial real estate faces more uncertainty going forward than offices. Companies found during the pandemic that work can be accomplished productively from home, and many workers found that they prefer shorter commutes and more flexibility.
Demand for office space will be reduced, and workspaces will be redesigned. The only question is how much of a disruption will occur.
Offices have taken quite a hit from COVID-19, even though the measurable cost has been obscured by the long-term nature of office leases. The U.S. office vacancy rate climbed to 15.9 percent as of April, up 280 basis points year-over-year, while sublease space has more than doubled during that time, according to Yardi Matrix.
That bump, however, is just the tip of the spear. Only about a quarter of downtown office workers nationally reported to an office as of April, with the percentage closer to 15 percent in New York City and San Francisco, according to security firm Kastle Systems. The question is not whether companies will reduce their office footprint post-pandemic, but by how much.
Demand for space barely scratches the surface of the considerations faced by owners and occupiers. The industry must come to grips with a host of factors, including when workers can safely return; how many people will use offices and how often they need to be there; where offices should be located; how offices interact with lifestyle preferences such as commuting and walkability and, how to re-design space to attract and maintain talent while meeting functional needs.
The industry is facing a “quantum fundamental shift,” according to Jeff Adler, vice president of Yardi Matrix. “The sector is at the beginning of a wrenching multi-year rethinking of the nature of work. Everything is in play.”
Where to Work?
The primary question hanging over the industry is how office utilization will change after the pandemic ends. “Every tenant is asking the same questions about how and when to get back,” said Benjamin Breslau, chief research officer at JLL.
Breslau said that the percentage of workers reporting to an office is expected to triple by year-end, to 75 percent, and that work-from-home will double to 20 percent of workers from 10 percent pre-pandemic. Many companies have found that workers can be productive from home, but to what extent can it be done without impacting corporate culture and collaborative efforts?
A consensus has formed around the idea that most companies will adopt more flexible arrangements, but what that means for office space demand depends on the details. In terms of how much space is needed, there is a big difference between giving employees a choice to be fully remote or requiring them to be in an office part-time.
Those decisions are complicated not just by employee preference but by the nature of the job and the industry. Some types of knowledge work (such as programming) can be performed well anywhere, but others are more productive in a collaborative environment. Daniel Ismael, a senior analyst at Green Street Advisors, said the average office worker’s time in the office will likely drop to 3.5 days a week from 4.5 days a week pre-pandemic.
While a part of the office space decision will be driven by the type of jobs and corporate culture, companies will also have to bear in mind the preferences of employees, which is another complex issue. If proximity to an office is no longer important, how will that change workers’ preference for where they want to live? In the years leading up to the pandemic, the default assumption was that young knowledge workers wanted to live in an urban environment. Job growth over the last 20 years has been concentrated in urban areas,
even in secondary and tertiary metros.
However, the pandemic prompted a drop in population in urban submarkets in gateway metros. Young families moved to suburbs to get more space while others who were suddenly unmoored from the need to commute moved to different parts of the country. Some moved to lower housing costs, but part of the movement was driven by the closure of entertainment and cultural venues. When those venues re-open, some will move back to urban areas, but others have left permanently.
Companies could deal with this by shifting offices to the suburbs or moving to less expensive metros, or by adopting a “hub-and-spoke” model with a city headquarters and outposts in the suburbs. Mark Grinis, hospitality and construction leader at EY Global Real Estate, said during ULI that a more distributed workforce is at odds with the need for collaboration. Studies done by EY of workplace productivity found that secondary locations—the “spokes”—had the worst performance.
Lifestyle Changes
COVID-19 has prompted many people to think about lifestyle and where they want to be. Many workers were relieved to avoid long commutes of more than 30 minutes, but “walkable” neighborhoods with access to shopping and other amenities remains popular. Diane Hoskins, co-chief executive officer of design and consulting firm Gensler, said that many are choosing smaller cities and inner-ring suburbs, especially in the technology sector.
“There’s a real appetite for reconsidering how cities work,” Hoskins said. “When you look at real estate as an investment in people, you say how do you do it in a way that optimizes … competitiveness to be able to thrive in a global environment.”
One difficulty for picking a location is that few metros are configured to meet conflicting worker preferences.
Lifestyle considerations mean that office buildings themselves need to be re-thought to meet the new paradigms. For example, workers may demand less density for health considerations. If workers come to the office less frequently, then more collaborative space is likely needed to make efficient use of the time they are together.
Companies may have to redesign space to add amenities to retain workers and/or entice them to come to the office. The myriad redesign changes, and even downsizing, are likely to require costly capital expenditures at a time when asking rents are flat or going down due to declining occupancy rates and competition from new stock.
Creating amenity-rich space and leasing flexibility seems suited for growth in coworking, although the coworking industry was hard-hit by the pandemic as the core business model—leasing large blocks of space and re-leasing at higher rates to small tenants—provide unstable when offices were mostly closed. Coworking will increasingly take a new form, one in which office owners partner with service providers to create flex space that is leased short-term and to smaller tenants.
Metamorphosis Coming
Transformation of the office market will take several years, as existing leases mature over the next decade and companies discover what employees want and what kind of space changes prove successful in the post-pandemic period. One thing that is clear is that there will be no one-size-fits-all model.
However it shakes out, companies will reduce space needs. Some of the reduced demand will be made up by job growth, but that is balanced out by the tremendous influx of supply that adds to stock. The result will be thinner margins, an increase in distressed debt, and likely lower property values, at least in some markets.
The stakes are high for employers because office space decisions impact human capital. Green Street’s Ismael noted that firms on average spend five to 10 times more on employees than they do on renting space, which means improving worker productivity and reducing turnover have a bigger impact on profitability than reducing the office footprint. “You don’t want to risk dollars to save pennies,” he said.
