07/20/2021 | News release | Distributed by Public on 07/20/2021 14:31
This article was originally featured in The Mid-Year 2021 Magazine,which contains research from Trepp and Commercial Real Estate Direct. Access the magazineto see more commercial real estate and CMBS insights.
As the number of coronavirus cases declines and vaccinations increase, some employees are beginning to return to their offices. Still, many companies are expected to adopt a permanent remote or hybrid environment, in which employees can work from home at least part of the time. That could have a profound impact on the office market.
During the week through May 12, only 27.8% of employees in 10 of the country's largest markets worked from their offices, according to Kastle Systems, a Falls Church, Virginia, company that installs security systems in office properties. That was up from a low of 14.6% last April, but down from 92.4% in early March of last year before the World Health Organization declared the pandemic. Kastle's data is derived from key-card swipes at office buildings.
In San Francisco and New York City, where government officials instituted the most restrictive lockdown policies, just 15.6% and 17% of workers, respectively, were back in the office as of May 12th. Austin, Texas, Houston, and Dallas, on the other hand, had the most employees back in their offices - 43.3%, 42.9%, and 42.3%, respectively. Texas reopened its economy sooner than most other states.
Meanwhile, in April, CBRE found that 65% of respondents to a survey it conducted said they had started returning to their offices. That was up from 58% in January. The brokerage had surveyed companies occupying a total of 285 million square feet. An additional 10% of the companies it surveyed were waiting for government approval to open their offices, while 25% had no set plans to return to their offices.
'We're going to see an office market that's going to take probably at least a couple of years to find its footing again,' said Ian Anderson, CBRE's head of research in the Americas. 'There's no doubt about it, more people are going to be working remotely,' he said. 'People are not going to be coming into the office every day of the week anymore. That is absolutely going to pressure demand and lot of office market fundamentals across the country to the downside.'
The pandemic already has had a major impact on leasing volumes, as companies have become accustomed to working remotely and remain uncertain about when they would return to the office and what their space needs would be in the future. During the first quarter, tenants signed 26 million square feet of leases, down 39.3% from 42.8 million square feet a year ago, according to JLL.
But demand for office spaceis seeing signs of improvement in major markets, as measured by VTS, a leasing management and software company that tracks 75% of the office space in Boston, Chicago, Los Angeles, New York City, Seattle, San Francisco and Washington, D.C. Tours of office buildings in those cities increased by 28.4% between February and March. But tour activity is still down 15.3% from the monthly average volume recorded in 2018 and 2019.
Economic conditions have also improved, with a 5.8% unemployment rate at the end of May, according to the Bureau of Labor Statistics, down from 14.8% in April 2020. And the International Monetary Fund projects that gross domestic product in the U.S. will increase this year by 6.4%, returning GDP to a level last seen early last year, before the pandemic. Still, JLL does not expect office leasing volume to reach its pre-pandemic levels anytime soon.
'There's a lot of very encouraging economic sentiment out there that tends to be very helpful for office demand,' said Scott Homa, JLL's senior director of office research. 'But companies need to get their bearings around flexible work and long-term plans about work-from-home before we start seeing big, substantive, long-term decisions being made.'
Since the pandemic began, most companies that signed leases have opted not to move. As a result, renewals and lease extensionsaccounted for about 70% of the leasing activity. That compares with 30% before the pandemic, JLL noted. The average lease term also has declined, to seven years in the first quarter from nine years in the first quarter of 2020.
Meanwhile, the U.S. office marketsaw 37.9 million square feet of negative absorption during the first quarter, meaning 37.9 million square feet of space that previously had been occupied became vacant. That was the second-worst quarter since JLL began tracking the office market in 2000, trailing only the 40.5 million square feet of negative absorption in the fourth quarter of last year. The national vacancy rate at the end of March stood at 18.2%, a 110 basis-point increase from the end of last year and the highest level on record.
Despite weak demand, office property owners have stuck to their guns, not discounting asking rents. But they've been getting more generous when it comes to concessions.
The average asking rent was $36.89 per square foot at the end of the first quarter, roughly flat from a year ago. But tenant improvement allowances have increased by more than 48% during that same time period, according to JLL.
As Trepp highlighted earlier this year, the glut in office space in both New York and San Francisco is a byproduct of the pandemic-induced distress that will require long-term observation. The New York City office sublease market has seen a large number of additions, with the amount of available space up 47% at the end of 2020.
Landlords are being forced to increase concessions to compete against sublease space, for which rents typically are 15% to 30% lower than direct space. Also, tenants often can find shorter lease terms with sublease space. JLL noted that the amount of sublease space on the market reached a record 151 million square feet at the end of the first quarter.
'The sublease spaceis generally more desirable for many tenants,' Homa said. 'It's a more efficient, economical option if you can find the right space.' New York and San Francisco have seen the most amount of sublease availability, with 17.8 million square feet and 5.8 million square feet, respectively. Those markets also have seen asking rents decline, with New York's average asking rent falling by 0.1% to $82.30 square foot at the end of the first quarter and San Francisco's average asking rent dropping by 4.3% to $82.16 per square foot.
Markets in the southeastern and southwestern U.S. as well as Texas have generally fared the best since the pandemic began, driven by people and businesses moving to the region due to a lower cost of living, lower taxes, and a better climate. In West Palm Beach, Fla., for instance, asking rents in the first quarter increased by 5.8% to $41.52 per square foot; in Miami, they were up 2.6% to $45.35 per square foot; and in Atlanta, they were up 0.4% to $29.46 per square foot.
'There was already a fair amount of velocity supporting the Sunbelt markets before the pandemic,' Homa said. 'They've generally held up the best, especially relative to the dense, urban gateway cities like New York and San Francisco.'
WHI Real Estate Partners, a Chicago investment manager, is among the investors that plan on staying away from the office sector. The company had been an active office investor since its founding in 2007 but is now focused primarily on apartments and industrial properties. It recently raised $385 million of equity commitments for its fifth fund.
David Rosenbaum, WHI's founder, and managing principal noted the company is also looking at hotels, which like offices have been hit hard since the pandemic. He expects demand for properties in that sector to increase significantly as people look to travel again.
'We're very cautious about the office sector,' Rosenbaum said. 'I think it's still too early to effectively assess some of the secular shifts that may impact office demand. That makes office cash flows very difficult to underwrite at the moment.'
MC Real Estate Partners, on the other hand, is more bullish about the office sector's future. The New York investment manager pursues investments in Boston, New York, and Washington, and has bought three properties in Boston and Washington since December.
The company's principals, Andy Nathan and Steve Grant have been involved in real estate for more than 30 years. Both had been with Tishman Speyer Properties of New York.
'The folks who have done well in prior down cycles bought a little earlier than leasing market fundamentals would suggest,' Nathan said. 'We do think more people will work flexibly from home a day or two a week, but we think office space will continue to be an important component of the business world.'
Tim Casey is a staff writer at Commercial Real Estate Direct.
Disclaimer: The information provided is based on information generally available to the public from sources believed to be reliable.