Reimagining Office While Working from Home

Andrew Foster is Associate Vice President in MBA’s Commercial/Multifamily Group. He is a former Analyst with S&P Global Ratings and Fitch Ratings as well as a regular contributor to MBA NewsLink and MBA Commercial/Multifamily NewsLink. Foster can be reached at afoster@mba.org or 202/557-2740.

How companies and their workforces will use office going forward is an increasingly popular subject in 2020. There are questions around existing buildings and how landlord business plans and those of their lenders will perform.

We have day-to-day available data that comes out weekly, monthly and quarterly which helps pull together market narratives. Lastly, there’s the longer-term trends and how demand will evolve for the asset class. 

Economic uncertainty is impacting office tenants and landlords, although the challenges of retail and hospitality properties command more attention from their immediate COVID fallout. In a market filled with unheard of amounts of liquidity and government intervention, questions abound: which firms are solvent and sustainable? For those survivors, what does their office footprint look like going forward? Does it move location substantially? 

To demonstrate the upside-down turn in market expectations brought about by COVID, the New York Times ran a story on October 14th, In The Pandemic, The Low-Rise is The New High-Rise. “The interest in groundscrapers reflects our evolving views on how we come together in office spaces,” said Sam Chandan, Dean of the Schack Institute of Real Estate at New York University.

The full impact of the pandemic and recession will only be understood as tenants and landlords make long-term decisions over time because some short-term volatility is buffered by long-term leases. Similarly, the economic results and unintended consequences from the massive responses from every level of government will not be fully understood until after the economy recovers. While the ongoing pandemic and its impact on near-term behavior is extremely impactful to tenant and landlord decisions and outcomes, the long-term impact on post-pandemic tenant space needs begs for speculation.

Commercial property sales collapsed during the second quarter due to uncertainty caused by the pandemic. During the quarter, sales volume for the four major property types was 68% lower than a year earlier. Sales of office properties fell 71% while the second quarter saw a 71 percent year- over-year decrease in the dollar volume of loans for office properties. 97.8% of office loans remain current as of the end of second quarter.

Fright Flight? The Suburbs See an Influx While Demand Wanes for Some Urban Cores

The Urban vs. Suburban variances serve as a proxy for variation in performance across different classes of office buildings, markets and submarkets in the current market environment. The size of the tenant would seem to be a potentially important viability driver given questions around which businesses will continue as going concerns despite COVID and recession impacts.

Even with all the chaos of shutdowns and the national work from home experiment, certain niches like data centers and medical office are seeing increased demand placing them in the resilient category with industrial properties. Supply and demand trends are showing up in the substantial growth of sublease space in soft markets which is often a leading indicator of coming challenges.

The Big Short Squeeze?

“In May, the Wall Street Journal reported that [Hedge fund manager Jonathan] Litt was shorting New York City office stocks, including Vornado Realty Trust, SL Green Realty and Empire State Realty Trust,” The RealDeal reported. In a six-page white paper, Litt warned of an “existential hurricane” making its way to the market and said Empire State Realty Trust would “bear the full brunt” of it. Stats from the first half of the year seem to bear this out. Manhattan office leasing activity in the second quarter was the slowest since the Great Recession of 2009. And then there’s the work-from-home dilemma for office landlords: what will remote work mean for long-term space demand and the value of office holdings in prime markets?

Moody’s Analytics predicts the value of U.S. office buildings will drop 17.2 percent in 2020. “Losing one tenant that occupies 30 percent of your space might have a very big multiplier effect on your income that puts you underwater really quickly,” Moody’s Economist Victor Calanog told the Wall Street Journal. But not all are as bearish. In a July 24 note, Michael Lewis of SunTrust Robinson Humphrey said it remains to be seen if office reductions become the norm rather than the exception.

Pandemic Pause or Revolution in How We Work?

TD Bank Head of Commercial Real Estate Gregg Gerken summarized his perspective in MBA Commercial/Multifamily Newslink here. “We’ve been tracking the leading indicators, such as unemployment, rent collections and occupancy. Those are three things we are paying attention to track the longer-term impacts of work from home,” he said. “The effects of work from home probably land somewhere between the two extremes of everyone working from home and everyone returning to the office. Even with the increases in work from home, the increased potential to work from home will be offset by a larger footprint per employee to create social distancing.”

CBRE’s Val Achtemeier, who specializes in arranging debt and equity for office, industrial and retail, told MBA Newslink here: “For office and retail, we are seeing more of an underwriting shift as investors are more conservative on lease up, rental rate forecasts and overall valuation metrics. Further, the bid/ask spread is fairly large on office assets with a lot of price discovery and broker opinion of value exercises.”

Referencing the West Coast where she resides, Achtemeier said West Coast office sales volume is down about 53% year-to-date, “and net absorption has been negative in most markets,” she said. “Single-tenant credit deals are still trading and in demand. The office capital markets sector has paused, but it will resume as activity returns. Credit quality and rent roll maturity schedules are getting a lot of focus on the debt and equity side. The West Coast region still has a very solid average occupancy at +/- 89% with a base inventory of 1.34 billion square feet. The office market will likely undergo some design changes and extra capex requirements for re-configured space, but we believe long-term demand for office space will continue to be solid in most of the West Coast markets. Leasing volume is down, and office tenants are being cautious with more shorter-term leases getting signed generally. I expect some distress to emerge in the office sector, but leverage levels are generally manageable, and investors were quite well capitalized going into the pandemic. I expect to see distress hit the retail and hotel sectors more severely than the office sector.”

While it remains difficult to know exactly what future office demand will look like across the country, MBA will continue to review and analyze the data. We look forward to more opportunities to do so from the office.