The impact of the yearlong pandemic on the office space market and associated rental rates has been one of multiple realities. Large tech tenants, large professional service firms, and large distribution and industrial tenants have continued to pay rent and maintain their tenancies. Midsize consultancy, boutique service companies, mental health providers, shared workspace providers and internet startups have seen a drastic reduction in footprints and associated rent defaults. Ground-floor retail occupancies have been the most severely impacted. Most office users have migrated to work-from-home or remote operations. Vacancy rates in the sublease market has increased dramatically in most metropolitan markets, signaling that market conditions will remain volatile for at least the first two to three quarters of 2021.
What will be the long-term impact of the pandemic on the future of work in the urban center? What will offices look like? Will companies need more space for social distancing, less space because of remote operations? Will dining and cafeteria facilities, quiet rooms, open work areas/work benches and gym facilities be cut back? Do some service providers (specialty insurance line carriers, traders, mental health providers) even need offices any longer?
While some business leaders say the pandemic has resulted in a clear shift away from offices to remote operations, the likely outcome is that the central business district office market will reemerge as a driving force, and that the trends we saw before the pandemic will accelerate when we see a return to a recovered economy—most likely in 2022. In other words, the recovery will not likely be a hockey stick, but a hammock. In speaking with institutional owners and executives at companies occupying large footprints of office space, two things come out: “company culture affects productivity” and “people want to be close to decision makers” (sometimes referred to as the “fear of missing out”).
The trends we saw before the pandemic will accelerate—a trend towards smaller office space size (but not hoteling), a trend toward “hub and spoke” (moving some groups to less expensive markets), and the trend of incorporating creative work spaces into the office design, where people can socially distance themselves while working in small groups. Cubicles are back—redesigned to provide greater health protection—workbenches are out. Cafeterias and dining facilities are in (firm culture and socializing); yoga and spin class facilities are out. People still need offices and “breakout” rooms are likely to proliferate.
Companies that compete to attract talent will continue to need well-designed and creative offices. That is what the millennials want. They do not want to work from home, at least not for long and not if it means being out of the loop on moving up within the company. A kitchen table is not conducive to creativity and innovation. Video conferencing is a poor substitute for building business relationships. Some markets appear to be weathering the pandemic storm better than others, but largely due to conditions that existed before the pandemic.
The pandemic is not likely to lead to a rethinking of the future of work. That trend was already in place before the pandemic, and once public transportation, restaurants and other retail can safely reopen, the vitality of the urban core will resume its relevancy and thrive. Offices will continue to evolve, with a new focus on lower density and a higher level of attention to air ventilation and health and safety modifications. Will rents return to pre-pandemic levels? Most likely not—with the exception of clear trophy buildings—but that was a trend that was in place before the pandemic as the run up in rents was already unsustainable. In this sense the office market will most likely follow the upside-down arches model—there will be rollers, with some users needing less space, and some—those that compete for the top talent—needing more space. Offsetting this is likely to be the expansion in occupancy in suburban markets.
The volatility in the office market will likely work to the advantage of full floor and multifloor tenants needing to make leasing decisions in 2021 even if for 2022 occupancy. There are very few comparable direct leases in the market today – given the oversupply of sublease space, the inability to tour space and the uncertainty of property owners on setting a base line “COVID-19 discount.” This will likely stabilize by the third quarter. Smart tenants may have greater leverage now than in the latter part of 2021.
Lastly, lease negotiations will likely be more complex and costly as both property owners and tenants need to sort out the allocation of risk and various costs of occupying office space resulting from the pandemic, which has exposed holes in many lease documents.
Manuel Fishman is a real estate lawyer at Buchalter, a California-based law firm, where he specializes in commercial leasing and the acquisition and disposition of all classes of real estate. He is a resident in the San Francisco office of the firm, where he serves as head of the office’s real estate group. He is active in many industry groups and frequently conducts podcasts and publishes client alerts on various real estate topics.