Work From Home: An Uncertain Future for Office-Space Owners, Renters

Chris Latham
Contributor

As governments at the state and local levels have enforced social distancing rules in response to COVID-19, the U.S. commercial real estate sector has begun adapting to a rapid increase in work-from-home activity amid the pandemic.

Developers and property owners are scrambling to determine how this will impact usage of office space in the years to come. Real estate companies must figure out how to continue collecting rent from existing tenants and how to woo new paying tenants, as well as what physical changes to make to current and future office spaces.

FIRSTHAND EXPERIENCE

Bruce Tulgan is founder and chairman of Whitneyville, Connecticut-based Rainmaker Thinking. He conducts talent assessment and strategic consulting as well as in-person seminars and keynotes for business leaders, and is the author of the new book The Art of Being Indispensable at Work. In late March – after the coronavirus outbreak started triggering massive shutdowns – Tulgan built a new production studio in his office, which is next to his home. Thanks to a flurry of e-commerce shipments, his new studio has computers and multimedia equipment as well as a green screen.

This new setup enables him to conduct interviews and focus groups, deliver strategic advice, and create programs for clients, all while working offsite from businesses. “All those onsite visits to companies have gone remote,” he says. “I have serious questions about whether all of that will ever fully come back.” And many of his clients have their employees working remotely, with return-to-office dates up in the air – at best.

OCCUPANCY TRENDS

If and when workers will return to the office is the big question that hangs over the office-space sector of the commercial real estate industry. Although some research indicates remote work makes employees less productive, a recent YouGov survey found that 54% of respondents said remote work during the pandemic has made people more productive thanks to fewer meetings, less distraction from co-workers, and the absence of daily commutes.

Due to coronavirus, huge firms including Facebook, Twitter, Google, State Street, Barclays, and Morgan Stanley have stated that they will allow more remote work and thus need less office space. Google has gone so far as to allow most of its employees to continue working from home until at least July 2021.

“Property owners are still in a wait-and-see mode in the industry to determine how tenants will change their use of space,” says Shawn Moura, Ph.D., Research Director at NAIOP, a national commercial real estate development association. “More office tenants will be used to the idea that their workers will go remote for up to a few days a week, and that may reduce the total amount of space they allocate for workers in the office.”

Yet Moura also notes that office tenants are expressing greater interest in having more space for workers when they do come into the office, in order to maintain social distance and avoid viral transmission — two things that are difficult to accomplish in a small or dense office environment.

The resilience of office space property owners and developers will depend largely on their ability to generate income from tenants who otherwise might engage in remote-work models, and on their ability to raise capital.

ECONOMIC FACTORS

According to Nareit, an industry trade association that represents real estate investment trusts (REITs) and publicly traded property companies, office sector rent collection for July 2020 was 96%, down only slightly from the 97% reported in June. Those figures may seem relatively strong, given that millions of Americans have lost their jobs during the worst downturn since the Great Depression.

But economic fallout tends to take years to manifest in the commercial real estate market, because most tenants have multi-year leases. Office building vacancy rates in New York City could climb from 8.7% this year to as much as 12% over the next two to five years, and from 5.8% to 9% in San Francisco, according to a Morgan Stanley report.

Banks, insurers, and private equity firms that provide financing for commercial real estate may be willing to renegotiate on loans to property owners, if necessary, since the Federal Reserve is keeping interest rates at rock-bottom levels. However, these financial institutions could prove reticent to underwrite new loans without a clear indication of office vacancy rates after 2020.

By other measures, havoc is already unfolding in the sector. New York commercial property sales in the second quarter of 2020 were a fraction of their 2019 levels. This year, between April and June, $3.6 billion worth of commercial properties were sold for a total value, compared with sales valued at $7.6 billion during the same time period the year before.

And the pandemic could cause an exodus of workers that would hit cities like New York especially hard. Barry Sternlicht, the billionaire founder of Starwood Capital Group, estimated that over the next three to five years, New York might suffer a 25% drop in office rents, along with a 25% rise in office expenses, that together might trigger a 40% drop in office values.

OWNER ADAPTATION

Meanwhile, owners and tenants alike are looking for solutions, at least short-term ones. Moura notes some office building owners are offering deals to new incoming tenants, such as rent concessions or paying for their move-in costs. In Cleveland, law firms are trying to persuade their existing landlords to lower their rent. In Chicago, tenants like the online discount-provider Groupon are seeking to sublease vast tracks of office space. Such moves are being played out in virtually every large city with substantial office space.

Not all office building tenants are suffering, though. WeWork, a large supplier of office co-working space nationwide, had a notorious financial collapse last year amid a rapid decline in valuation that saw it postpone its IPO and change leadership. Yet the company claims that its flexible office spaces have garnered strong demand during the coronavirus pandemic, from large firms including Mastercard and Microsoft that want to provide employees with low-cost alternatives to working from home.

WeWork membership starts at $45 per month. The company reported that large firms increased their occupancy of WeWork desks from approximately 19,000 in 2017 to approximately 284,000 in the first quarter of 2020, and that for all the firms it serves WeWork leased nearly as many desks in June as it had in February — just before the pandemic lockdowns began.

In the future, office buildings may have to appeal to the health-and-safety needs of tenants by adopting specialized designs and technologies, according to Moura. He outlined such ideas in the June NAIOP Research Foundation report Navigating a Safe Return to Work: Best Practices for U.S. Office Building Owners and Tenants.

In addition to layouts that accommodate greater onsite social distancing, office buildings could add electronic sensors that trigger automated controls to reduce the need for touching surfaces. Other innovations may entail modernized HVAC systems to improve air quality, and building materials that prevent microorganisms from clinging to surfaces.

Steve Weikal, Head of Industry Relations at the MIT Center for Real Estate,  sees more robust tenant engagement platforms and robotics as fields with major potential for growth in office buildings. Employees can use employer or building-supplied software to book rooms and even desks at specific times. Automatic elevators can detect the number of bodies inside them, and control which floors individuals access. Robots can move around to clean rooms, emit ultraviolet light to kill bacteria and viruses, and warn people when a room reaches maximum occupancy.

“Prior to COVID-19, some of these solutions already were beginning to gain traction. Now they may become mission critical in getting people back into buildings and maintaining safety. Buildings might adopt a whole new level of smart technology,” says Weikal, who acknowledges that implementing them could introduce legal questions. “How do you balance privacy with keeping people safe and having enough data to make reasonable decisions? And whose responsibility is it, the property owner or the office tenant?”

TENANT DEMAND

Moura points out that tenants, especially those in dense urban areas, have recently expressed greater interest in suburban office buildings that offer more spacious layouts and lower rents and may be located closer to where workers live.

Since it remains to be seen whether this will be a durable trend, Moura expects that in the short-term, office building owners and developers are more likely to respond to shifting demand by investing in renovating existing suburban buildings rather than new ones. Developers are less likely to invest in new office buildings, particularly those in urban downtowns, until leasing markets improve.

“A lot of investments that improve safety also improve sustainability and efficiency,” he says. “For example, building owners may want more space, better air quality, and touchless sensors regardless of a pandemic. But it depends on tenant demand. If there is a durable trend in tenant demand for these things, you can expect the money to follow.”