The Showdown at the Virtual Office Corral
There’s good news in commercial real estate this week. The number of people coming in to the office is at its highest point in 42 months – since the start of the pandemic.
The bad news, according to the weekly survey by Kastle of its clients in 10 major cities, is that the number is barely half (50.3%) what it was before the pandemic. Based on some projections, the numbers may tick a bit higher over the next twelve months, but the bottom line is pretty clear: the number of people working in offices is not going to get back close to where it was before the pandemic (curiously, it appears Asia could fully recover, and Europe and the Middle East will get much closer to prepandemic levels. But that’s a separate post).
Post-pandemic, more Americans have decided they are very comfortable working from home. A survey released last week by the US Census shows nationally about 15% of Americans are working exclusively from home, with significantly higher percentages in tech-heavy metro areas:
1. Boulder 32%
2. Austin 28%
3. San Francisco 27%
4. Raleigh 26.1%
5. Seattle 25.4%
6. Washington DC 25.4%
7. San Jose 24.4%
8. Bend OR 24.2%
9. Denver 23.7%
10. Portland, OR 23.3%
11. Ann Arbor 22.6%
12. Charlotte 22.3%
13. Phoenix 21.7%
14. Durham-Chapel Hill NC 21.6%
The number of people working fully from home is up in every state post-pandemic. In some metro areas it’s more than 1 of every 4 workers. (Photo: Helena Lopes, Unsplash)
The percentages are much lower in nonmetro areas across the nation and in the Southeast generally – in Mississippi, for example, just 5.5% of workers are fully remote. But the numbers working all-remotely are higher than before the pandemic in every state.
Even more people are working partially from home – one survey in New York City showed only 9% of employees were coming in to the office five days a week.
Both trends have made for a painful three-plus years :
· For companies trying to figure out how much office space they need;
· For developers trying to determine how much office space to build or how to keep their buildings occupied;
· For banks who have begun to realize their loans for new buildings are not as safe as they thought; and
· For businesses like restaurants and others that depend on office workers to stay alive. “Remote work is killing downtown areas,” Henry Fonvielle, President of Rappaport Companies, a commercial real estate management company in McLean VA, wrote me. “It is extremely difficult to staff a restaurant when you only have business Tuesday, Wednesday and Thursday.”
It’s going to get even trickier for all of those groups soon, as short-term loans come due, long-term leases expire and we try to resolve what the post-pandemic work world looks like.
Here are five things I think we can be confident are going to happen over the next two years:
1. Faceoff on face-to-face – The pandemic launched an instant work-from-home experiment. That was followed by an ongoing shortage of workers. Those two things combined gave employees both a taste of working from home and some leverage to continue it. A McKinsey survey last year showed that “flexibility” now ranks only behind salary among employee priorities. Meanwhile companies increasingly want employees to come back to the office. Lyft, which had initially promised no return to the office, reversed course and is pressuring employees to come back. The CEO of Zoom said Zoom can’t bring his employees meaningfully together (in a leaked conversation he said basically that you can’t build trust and innovate over the platform) and told employees they need to return to the office.
Those companies are not alone. A CBRE survey earlier this year showed 45% of employers want to return to a “mostly” or “fully” office culture, and 38% of employers are “expecting” attendance in the office to increase in the next year. But workers are pushing back. Amazon and Starbucks have faced protests over their “return to the office” plans. Goldman Sachs gave employees an ultimatum last year – and attendance is still off 10-15% from pre-pandemic levels. Salesforce is offering to make donations to charity for employees who return to the office.
Bottom line: The next year is going to be a big one for the remote work question. As the worker shortage eases, companies are likely to have more leverage in bringing more workers into the office for more days. Firms that are more dependent on face-to-face interactions (like financial services companies) will push harder and end up with a greater percentage of workers in the office than, say, tech firms. Owners of office buildings will have to work with tenants to make the office environment more attractive than home (see “great redesign” below).
2. Location, location, location and, uh, LOCATION – Location has always mattered in real estate. It will matter more in the future for office buildings. “In the past employees might be completely satisfied in going to work in an outlier location provided you had really great space or really cool product,” Brad Corsmeier, Executive VP and Director of Investor Leasing for CBRE Raleigh, told me. “Post-pandemic, offices in poor locations are going to struggle.” If people are going to come back into the office, the office will need to be easy to work in, easy to get to and close to the things they need – food, shopping, day care, etc.
Bottom line: Companies currently in office buildings with locations that don’t have surrounding amenities will either need to find ways to supply those in-house or reduce their potential employee pool to those living closest by. Or they’ll move. Bad news for the owners of the buildings they leave behind.
3. A great redesign – The advice the owners of office buildings most often get from outsiders is: “Hey, just convert your building to a different use.” The most common suggestions: convert it to apartments, or warehouse space, or lab space. The biggest problem with all the ideas is that office buildings were built to be – office buildings. If you want to make them warehouses or lab spaces, you may be able to charge good rates for rent, but only if you can figure out how to raise the ceilings and put in new elevators and improve the ventilation and strengthen the floors. If you want to make them apartments, you’re going to have to get them rezoned, then figure out how to put in more windows and bathrooms.
Bottom line: The best opportunity for redesign is to make the offices better offices. “There’s no one thing or blanket trend people are doing,” says Corsmeier. “It depends on the user.” Some buildings are adding flex space, he says, others more lounge areas, with sofas and white boards and TV’s. The goal appears to be creating what Corsmeier calls a “living room experience” to replicate some of the feel workers had when they were at home.
To bring back workers accustomed to working from home, offices will try to create more of a “living room” experience. (Photo from Austin Distel, Unsplash)
4. A painful purge – Before the pandemic, three-quarters of Americans did no remote work and only 6% worked fully remotely. The pandemic has fundamentally changed our perspective. That means, going forward, a significant portion will continue to work fully remotely and very few will need full-time office space. That means less office space needed per employee. Which buildings lose in this scenario?
Corsmeier sees it playing out this way for the office market he knows best, Raleigh, NC: "The top third (of buildings) are going to do well, the middle third are going to plug along, probably at a lower rate and concession package; the bottom third probably needs to get scraped.”
Bottom line: Office building owners at all levels are going to be investing more in upgrades or amenities if they want to maintain rent levels in a market with greater vacancy rates. Those in the “scraping” category have few options. A small number may have the kind of building and cash they can convert office space to lab or warehouse space. The vast majority will have to either invest large amounts of money (which they would have to try to get from banks — see #5 below) converting the buildings to residential space, which they will then have to either rent at a significantly lower rate, or sell their buildings at a heavy discount to someone else who can figure that out.
5.. A “doom-loop” for lenders and borrowers – A Wall Street Journal article earlier this month found that banks of all sorts, but particularly regional banks, dramatically increased their lending to commercial real estate projects between 2015-2022, roughly doubling their exposure to $2.2 trillion. Nearly $900 billion of those loans are coming due in 2023 and 2024.
Bottom line: As the loans come due the value of many buildings has decreased while interest rates have increased. Developers who originally borrowed at 3% interest loans are now being asked to pay 7%. At the same time their tenants are asking for lower rates or less space. In some cases banks are already finding themselves owners of devalued real estate as borrowers are unable to pay the interest. What the Wall Street Journal calls a “doom-loop” scenario is beginning to play out. One regional bank, M&T, told shareholders earlier this year that 20% of its commercial real estate loans are now at higher risk of default, then tried to sound an optimistic note: “It won’t be Armageddon all in one quarter.”
What happens to office space when only 50% of employees are in the office? We’re about to find out. (Photo from Omar Flores, Unsplash)
Every area of American life has had to do some kind of rethinking in the wake of the pandemic, and that reckoning has been painful for so many. And crises almost always look more hopeless when you are in the middle of them. So let’s take the term office space “Armageddon” off the table and just say these are deeply troubling times in the world of the American office. It’s going to take every ounce of every skill everyone has developed over their work careers -- bankers, developers, leasing agents, tenants and surrounding businesses -- to manage through this transition.
-Leslie
References:
Kastle “Back to Work Barometer”: https://www.kastle.com/safety-wellness/getting-america-back-to-work/
Return to office rates in other regions of the world: https://www.wsj.com/articles/as-americans-work-from-home-europeans-and-asians-head-back-to-the-office-db6981e1
US Census data on work from home (you can search by state and county also): https://data.census.gov/table?t=Commuting&tid=ACSST1Y2022.S0801
Trends on forcing people back to work: https://www.bbc.com/worklife/article/20230622-why-workers-are-still-winning-the-return-to-office-fight
Axios on Census data: https://www.axios.com/local/raleigh/2023/09/19/remote-work-jobs-north-carolina-wfh-statistics
CBRE Mid-Year Report findings on office space: https://www.cbre.com/insights/books/midyear-global-real-estate-market-outlook-2023/office-occupier
Zoom CEO on building trust over Zoom: https://www.businessinsider.com/zoom-ceo-employees-return-to-office-2023-8
CBRE survey of office attendance: https://www.cbre.com/insights/reports/spring-2023-us-office-occupier-sentiment-survey
Different strategies to get workers to come back: https://www.washingtonpost.com/business/2023/06/08/google-salesforce-return-to-office/
Wall Street Journal on the “doom-loop” in commercial real estate: https://www.wsj.com/real-estate/commercial-real-estate-regional-banks-9f8f591d