With office vacancies at an all-time high in major markets across the United States, what does the future hold for some of the work locations that never reopened after the pandemic?
Predictions abound when it comes to what exactly is going to happen with commercial office space. It seems almost every publication has cast their vote about what they anticipate is going to happen to office space in major metropolitan areas in the coming years, as well as some of the context for those predictions.
Forbes pointed out recently that the rising cost of construction and the continuing increase in office vacancy rates is making it very difficult for the sector to bounce back, “...some areas will deal with Covid’s legacy a lot better than others with warehousing in the lead for the time being, and office building, once the darling of the sector, bringing up the rear.”
Globe St, on the other hand, correlated some environmental factors to the continued decline of office occupancy such as crime rates and a lower quality of living in cities across the United States. Commercial Observer provided some additional nuance, pointing out that office occupancy is faring better in New York City than in San Francisco where office space, pre-pandemic, was largely occupied by tech companies.
So what is the future of office real estate? It is very hard to say, it’s complicated. But from our experience working with a number of large real estate firms in predominant markets like New York City, San Francisco, and Chicago our own data does not suggest a “the sky is falling” scenario in the office sector of CRE. Any changes though will have an effect on the general health of the real estate market, and therefore this property class is particularly important to keep an eye on.
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The Current State of Office Assets
Recovery for Some, But Not for All
Demand for Shorter Lease Periods
Why We Aren't Ducking for Cover Just Yet
Other Changes on the Horizon
One of the reasons it is so difficult to predict the future of the office real estate market is due to the unpredictable circumstances that led to its current state. In 2019, office, industrial, multifamily, and retail properties were experiencing steady growth. Office assets in particular, were just starting to recover from the hit they took during the 2008 recession. Well, we all know what happened next. This progress all but stalled completely when COVID started to impact major markets in the US in March 2020.
Today, continued economic uncertainty and a corporate culture shift to work from home has left office occupancy lagging behind pre-pandemic rates. So it isn’t surprising that these conditions have created some stunning data points about office real estate.
The sum of these factors, widespread downsizing, the slow return to office in major cities, and higher rates of sublease space are all pointing to some major office real estate trends to come in the coming quarters.
Looking at some of the statistics regarding the current state of the office real estate market in the United States, it’s clear that recovery is occurring in some markets across the country. Salt Lake City, for instance, experienced one of the fastest post-pandemic rebounds out of the top 50 metro areas in the US. Conversely, San Francisco is experiencing office vacancies at an all-time high.
Real estate experts, like those at Colliers, offer some explanation as to why certain cities’ office sectors have had a higher rate of pandemic recovery than others: industry. For instance, in Salt Lake City, industrial banking is a leader in the economy. Trade, transportation, and military follow closely behind. Meanwhile office sectors dominated by tech, like San Francisco, currently have some of the lowest office occupancy rates in the country.
Then, there’s Austin, Texas. The proverbial wrench in an otherwise ironclad theory. Austin, one of the largest tech hubs, has outpaced the rest of the country in office job growth, maintaining a staggering 23.7% job growth since the beginning of the pandemic. Which introduces yet another variable experts are watching to gauge what will happen with the office real estate market.
In addition to industry, the data shown in Colliers’ office report also suggests markets with greater tenant flexibility, in the form of discounts and short term office leases, are proving more successful in driving the workforce back to physical offices.
According to Colliers, Austin has “ample sublease space available” offering tenants move-in-ready spaces with flexible lease periods. This is also creating an environment in which landlords are more likely to offer tenants discounts for subleases as well as concessions.
In addition to these short term office leases, cities like Palm Beach are attempting to bring back their in-office workforce by breaking ground on new buildings in 2023 and filling them with the premium amenities employees emerging from home offices are seeking post-pandemic.
The data from Colliers and our own platform tell, in a sense, the same story. The next year or two will be difficult for those with office property, but the sky isn’t falling. True, markets such as The Loop in Chicago, New York City, and San Francisco are facing challenges with office space occupancy, but the general data reveals a lease expiration schedule that is categorically manageable.
Across the United States, at the moment, office occupancy currently sits in the mid-eighties. While this is in fact lower than the approximately 95% occupancy rate this particular property class held before the pandemic, the lowest participation rates are relegated to pockets around the country, leaving the general outlook relatively sunny, given the circumstances.
Heading into this era of relative unease it will be highly important for property and asset management teams to have total transparency and measurability of their portfolios. After all, as the saying goes, “You can’t manage what you can’t measure”.
One of the biggest challenges CRE has faced—even before the pandemic—is data or, more specifically, portfolio data management. CRE is one of the largest business asset classes in the world and its professionals habitually work with massive sets of data to carry out everything from lease abstraction to portfolio management activities. What’s more, many of these processes are still conducted manually with portfolio data from disparate, unstructured sources. As you may have guessed, this leaves room for human error and can come at a time expense for teams that are often spread very thin.
That’s why Prophia is stepping in to bring some ease into the process of portfolio management. With a powerful machine learning model, this AI-powered tool digitizes lease documents quickly and accurately saving CRE professionals time when it comes to due diligence, lease abstraction, and property management. This efficiency has also helped many of our own clients with office space reduce costs and discover unrealized weaknesses and opportunities in their portfolios as we all continue to trudge through uncertainty in the market.
Commercial real estate is a slow-moving industry capable of shaking the ground. That is to say, the future of office real estate markets will affect industries beyond CRE. Some markets may experience a rebound here or there as landlords and tenants adopt more flexible lease agreements, or the shift to work from home may cause many offices to remain unused, prompting firms to sell or convert their office assets. Whatever the future of this specific property class may hold, experts will continue to offer their predictions, ever-aware of the unpredictable.