The COVID-19 pandemic has delivered a shock to every major commercial real estate asset class. Unlike other property types, however, the recovery of the office sector is not as certain. Surveys suggest that office employees like to work from home and companies can save money by keeping them there.
Many office employees will likely continue to work remotely after the health crisis has passed. This has implications for how office properties are designed and used, as well as their core fundamentals, prices, and prospects of getting sold and financed. The work-from-home trend, however, also is creating new opportunities for commercial mortgage brokers inside and outside of the office sector.
COVID-19 has changed how we work. Since the start of the pandemic, numerous businesses have closed their offices and required employees to work from home. Nearly nine in 10 companies adopted some sort of remote-work measures during the first month of the health crisis, according to research and advisory company Gartner.
This shift to a dispersed workforce has implications on the commercial real estate industry, particularly in regard to office space. According to a Clever Real Estate survey of 1,000 remote and in-office workers, some 63% of employees prefer working from home to the traditional office setting, and nearly 30% plan to continue working remotely after the pandemic.
But it’s not only employees who have enjoyed remote work. Many companies have started to realize the benefits to their bottom line, especially for reducing overhead real estate costs. Large corporations, such as the computer technology company Dell, have saved millions of dollars by having employees work from home. Meanwhile, 53% of larger organizations say they plan to scale down their offices after the pandemic, according to a Cisco global workforce survey released this past October.
What does all of this mean for the future of office space and where should mortgage professionals focus their efforts when looking for new clients? To answer these questions, we have to examine how remote-work culture is molding office-space trends, the potential long-term financial impacts of the pandemic on the office real estate market, and the overall future of the commercial real estate industry.
Unsurprisingly, many people enjoy the newfound freedom of working from home and realize the benefits for their work-life balance. Respondents from the Clever Real Estate survey most enjoyed the added flexibility in their schedules, saving time and money by eliminating their commutes, and spending more time with loved ones.
Although people clearly love working from home, as do many employers, there also is evidence that people miss going into an office. According to Envoy’s most recent workplace report, the majority of U.S. employees feared a return to the workplace this past fall due to health concerns, but 94% wanted to go back to the office at least one day a week.
A study conducted by Steelcase of more than 32,000 workers worldwide corroborates this. Isolation was the biggest concern for remote workers, the study noted. Many people wanted to return to the office to reconnect with colleagues and their organization’s shared purpose.
That being said, workers also do not want to give up the flexibility of working from home. Essentially, people want the best of both worlds — to be able to seamlessly switch between group and solo work in both physical and virtual settings.
This means that the commercial real estate industry’s approach to office design and functionality must evolve with the changing attitudes about office functions. It also means that future office spaces will likely be smaller and used less often.
The cultural changes toward office space brought about by the pandemic have been reflected in the sector’s core fundamentals. Although vaccine rollouts have given real estate finance professionals cautious optimism about the market, the fact remains that 2020 was defined by dramatically decreasing occupancy, high vacancy rates and limited leasing.
A January 2021 report from JLL suggests that COVID-19 significantly reduced demand for U.S. office space last year. In 2020, gross leasing totaled 125.6 million square feet, a 47% drop in activity compared to 2019. Total occupancy declined by 84 million square feet in 2020, pushing up the nationwide office vacancy rate to 17.1% at the end of the year.
Two other trends suggest that companies have reduced their space and also are reluctant to sign long-term leases. First, the sublease market expanded by more than 50% since the start of the pandemic with more than 141.5 million square feet of sublease space on the market at the end of 2020, JLL reported. This indicates that the original leaseholders have been shedding space or have moved out entirely. Second, lease durations have been declining and are now typically being signed in the three- to five-year range.
Some nuances, however, lurk beneath these aggregated numbers. First, vacancy rates rose twice as fast in central business districts (CBDs) than in suburbs. Meanwhile, the CBD occupancy losses were more concentrated in Class B properties, suggesting that companies are still interested in quality properties in city cores. Occupancy losses also have been more heavily concentrated in gateway markets, such as New York City, the San Francisco Bay Area, and the tech- and energy-oriented markets of Seattle, Boston, New Jersey and Los Angeles, according to JLL.
It is unclear when or if the demand for office space will bounce back. JLL projected only a moderate pickup in leasing for the second half of 2021. An unsurprising effect of this uncertainty has been a decline in office lease and sales prices.
At least for the foreseeable future, investors can expect office values to remain flat or decrease, given that many expensive areas such as the Northeast, Texas and California are experiencing major drop-offs in rents. Deloitte’s 2021 commercial real estate industry outlook noted that U.S. office-price indices declined by 0.5% year over year in August 2020. Although average rent collections for the office market have remained healthy, tenant incentives and concessions made by landlords have contributed to value declines.
Although the demand for office space may experience a permanent reduction, other commercial real estate sectors have benefited from the work-from-home trend. One consequence of remote work has been the mass migration of people out of historically popular downtown areas and large cities into new neighborhoods and even new states altogether. Commercial mortgage brokers must keep an eye on these shifts to identify potential new business.
This migration, paired with historically low interest rates and low housing inventory, has increased the need for single-family rentals and apartments in suburbs and other areas of the country that are seeing an influx of new residents. Moreover, CBRE research indicates a boom in demand for industrial space driven by the rapid rise of e-commerce, with nearly 80% of U.S. industrial markets expected to see positive rent growth over the course of 2021. Additionally, as more businesses seek industrial space, there is enormous opportunity for investors to flip outdated buildings and unused retail space into warehouses and fulfillment centers.
Passive investment options, such as crowdfunding apps and real estate investments trusts, have become more popular during the pandemic. Platforms such as Fundrise, Robinhood and RealtyMogul have put the power directly into the hands of consumers, driving strong interest from people who had never previously considered investing in commercial real estate.
Although the pandemic has likely created long-lasting changes to the office real estate market, there is still a need for office space in this world. Even though people enjoy the freedom of remote work, they also want to interact with their peers and have face-to-face meetings.
Future offices, however, will likely look drastically different than what we are accustomed to. Their usage and designs will vary by company and industry much more than prior to the pandemic. And although there has been a dip in the office market, there has been increased demand for the industrial and multifamily-housing markets. If this pandemic has taught us anything, it’s that we should not fight change but embrace it, and that goes for the commercial mortgage industry as well. ●