Sea change or temporary adjustment?

The demand for office space

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There have been three key impacts on office real estate since COVID-19. They include significant slowdowns in decision-making, few people returning to offices despite restrictions lifting, and an increase in office space lease listings. For example, despite the 50% capacity that New York office buildings could reopen at and the expected 15-20% return, there was only 9% that actually returned to work. Will shifts in the demand for office space be temporary or are new trends here to stay? While we do not aim to provide property investment advice through this article, we share our thoughts on shifts in the market as we see them, and how we estimate they will have an impact on real estate businesses.

The demise or demand for commercial space

Many are wondering if major cities such as New York, London, and Tokyo are going to experience a reduction or increase in demand for commercial space. There are negative and positive angles we can look at:

Negatives:

  • It’s going to take a significant amount of time for people to feel comfortable using public transport in urban areas
  • It’s difficult to practice social distancing in elevators and other areas of office towers where there are 5,000 or more workers
  • If social distancing becomes the norm, even if fewer workers are present, you might still require a similar amount of space

Positives:

  • There are long-established critical masses of amenities, businesses, clients, and peers that cannot be replicated elsewhere
  • In-demand professionals, such as knowledge-based and skilled Millennials, find that downtown areas provide the work and environment experience they desire
  • If there is a significant reduction in rental fees, high-end downtown buildings become more feasible for those who found them unaffordable

When it comes to consideration for cities to overcome the challenges of the pandemic, there are two key factors to look at: The business sector’s tenant base and drivability.

Tenant base:

The cities most dependent on the sectors hit by the pandemic are going to experience the most difficulties. Examples include the energy sector in Houston and tourism in Orlando and Las Vegas. Cities with stronger and more in-demand sectors should see fewer challenges, such as biotechnology, life science, and technology sectors in San Francisco or Toronto.

London and New York are examples of diverse and established cities that are well positioned to weather the storm. Due to a constant presence of government, cities like Washington DC are insulated.

Drivability:

People might remain reluctant to use public transportation for the foreseeable future. This could lead predominantly car-borne cities to be more appealing than those relying on public transport for their daily commute. People may also gravitate toward smaller communities featuring attractive environments and lower costs.

Reassessing office requirements

In many countries, employers are in the early stages of re-entering the office and large numbers of employees remain working from home. Therefore, it’s going to take several phases of reopening to determine how space requirements will change long-term. Reassessment could mean moving away from companies having a single, downtown headquarters.

An idea that’s gaining traction throughout the US is the “hub and spoke” model. This model means keeping a central headquarters and implementing smaller suburban hubs for workers. Suburban locations are beneficial because, space is cheaper, workers can move around the building, and public transportation issues are eliminated due to car use.

The incorporation of flexible, drop-in spaces is likely going to occur to give work from home employees options to work in a facility. There’s likely going to be a significant number of employees working full-time from home where job specs allow it. A working from home culture is most likely here to stay.

The office will be a destination where people can meet, collaborate and interact, and experience the brand and culture of their employer. A possible requirement for office space in the future is therefore a space that allows more interaction and brand experience rather than traditional workspaces. Ultimately, large companies benefit from offering choice-based strategies in the workplace. One of the most significant challenges workplaces are going to face is that some people (possibly younger staff) might feel suburban offices are less attractive and even boring to work from. Consider individual employee’s needs includes reassessing lifestyles and work-life balances of your workforce.

Implications for real estate owners and investors

There is no one-size-fits-all approach to the implications for real estate owners and investors, or how they should shift their strategies. Depending on the factors we discussed above, strategies are going to vary. That includes market strength, as well as the property’s age and quality. It’s clear that owners want to preserve cash flows (i.e., rental income), and tenants want to lower payments.

There’s typically a rise in “blend and extend” leases during a recession. While tenants see a drop in rent, landlords can secure longer income streams. For several years, capital placed in suburban assets has outpaced downtown property investments. Some wonder if this is going to increase if occupiers move to diversified occupational strategies. A key issue is the extent to which businesses view impacts of COVID-19 on the nature and location of work regarding short-term hiatuses or long-term occupational changes.

The co-working space business model is a subcategory within office real estate that has been severely impacted by the pandemic. The collaborative nature of co-working spaces is making social distancing difficult, and the flexible contracts have led to many occupants to terminate contracts when the pandemic first started. The silver-lining for real estate owners running co-working offices is that the flexible nature of the business models also means it is easier for them to pivot towards new office space products and reinvent the ‘space as a service’ model.

The greatest issue owners and investors might face could be their desire for flexibility. Overall, we can expect occupiers to seek short-term lease commitments. That creates shorter income streams, which might have ramifications on hold periods and valuations. The immediate future might include a branched approach to investment strategies involving low-risk assets or the opportunistic purchase of discounted properties.

So, what will stick?

The impact COVID-19 has on the office sector continues to unfold. If the pandemic lingers on, we can see many of the temporary changes becoming entrenched into office cultures. That includes online meetings, social distancing and working from home. If the pandemic lasts, then we can also expect companies to implement longer-lasting changes in their professional portfolio.

For example, some companies might consider short-term suburban property leases until events blow over. If they don’t, that could mean searching for longer commitments. Office sectors can adapt by further embracing two key concepts—flexibility and choice. As we noted earlier, tenants are moving toward a more geographically diverse premises strategy coupled with more flexible lease terms.

In recent years, attracting and retaining talent by providing the best workplace experience is just as critical as its location during property selection. It’s going to be incredibly essential to provide employees with choices regarding where and how they work while seeking to provide the optimum experience.

Ralph Mitchison

Global Real Estate & Construction Industry Leader

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