The pandemic has impacted real estate severely in March and April, but it is rebounding. How will commercial, specifically office space, be impacted in the coming months?
It’s the bustle of office buildings that shapes a surrounding city, from the flow of rush hour traffic to the growth of surrounding streets. And with a couple of executives always burning the midnight oil, office buildings have been the giant nightlights in our cityscapes.
The pandemic has impacted all sectors of real estate, but the gaping hole it’s left in the office market is painfully visible. In an April report, real estate firm Marcus & Millichap estimated the amount of remote employees has grown from 3.5% to 43%. Leaders such as Morgan Stanley have been vocal about permanently decreasing their company real estate. Investors and landlords are facing a future that seems particularly grim.
The truth is it’s likely too early to draw a firm conclusion. Many companies have found success working remotely, but decisions made in the midst of the pandemic may not hold. What does it look like to have four quarters without social proximity, in-person talent mentoring, and a real space with which to recruit or onboard new team members? We’re still not sure.
The office sector faces concrete challenges, but there are a number of counter forces that could sustain or increase demand. These factors in combination don’t provide a clear answer, but perhaps more importantly, they surface the right questions.
The Challenges Ahead
Some damage is inevitable, and unfortunately, specific parts of the office sector are likely to bear the brunt of it. Industries in which workers already spent a significant time out of office, such as consulting, accounting, real estate brokerage and sales-based operations, will likely stand firm in the minimization of their office space. Buildings with such tenants are likely to see a slower come back, if at all.
Moreover, a new dichotomy will emerge between ‘safe’ and ‘unsafe’ buildings. Safety will put new demands on building owners; upgraded air filtration, frequent professional cleaning, touch-less bathroom fixtures, among many others. If the full cost falls on the landlords, who have already suffered a record-low quarter and who face a more competitive market than ever, it might be a setback that can’t be overcome.
The Almost Bright Sid
In decades past, tenants have gone to some extremes to make the most of their office space. The average allocated employee space has decreased from 250 square feet to less than 150 square feet, and as low as 60 square feet in the co-working space. An inarguable effect of COVID-19 will be the reversal of this densification. The new regard for space and safety among employees will mean tenants need more space, even if they return with a smaller team.
Another silver lining has been the hold on new developments. The risk of overbuilding has drastically decreased. This means office sector competition will be true to market and quality dependent. Modern buildings with the capacity to fulfill safety measures could actually see an increase in rent.
An Emerging Market
According to a study on office real estate published by UBS Group, it’s possible that we’ll see a revitalization of the suburban office market. An evident trend in past years has been the move away from cities and toward suburban areas with more favorable business climates, such as shorter commutes, more space, and lower costs of living. The trend will likely be exaggerated as city dwellers experience some loss of income, and as shoulder-to-shoulder commutes become intolerable for new reasons.
Now that companies understand their ability to work at a distance, they might consider overflow space in suburban locations and submarkets as a place for remote workers to gather. Smaller suburban offices could help them strike a functional balance between ensuring safe and spacious conditions for their employees while maintaining the coherence of their team.
Far from hopeless, the fate of the office real estate market will be swayed and shaped by many forces. The challenges ahead are not to be understated. Tenants will leave, and those who stay will have costly expectations that landlords may not be able to fulfill. But equally important is the de-densification reality, the reduced risk of market dilution, and the new potential for suburban markets to thrive.
Landlords, companies, and tenants alike should approach the coming months with a willingness to adapt and improvise. Communication is important, transparency is necessary, and it’s best to focus on the horizon rather than the front-page headline. People who love what they do often love who they work with, and community in any form is an important part of our lives. A new normal lies ahead of these dark and sleepless nights, and it may not be the nightmare we expected.
Zain Jaffer is an entrepreneur and the Founder and CEO of Zain Ventures, an investment firm with over $100 million in assets under management. Zain Ventures operates a variety of commercial real estate initiatives across the United States with a current portfolio of 17 projects across 11 states.