Sell for More Trivia is a weekly blog series that playfully presents a trivia question about commercial real estate.
The Great Lockdown of 2020, rightly or wrongly, has set off a chain reaction that may change demand for office space forever. Changes to our work routines have been so significant that some will be permanently adopted.
Short-term impacts
Federal regulations provided tenants with an opportunity to defer rent payments. This imposed cash flow burdens on many owners. Those with federally-backed loans may be able to obtain deferral of their mortgage payments, but those with outside commercial financing are being squeezed.
For tenants who remain solvent, deferred rent will be repaid over time, but a looming concern regarding owners’ cash flow focuses on the potential for tenant bankruptcies and business failures.
“Stay at home” guidelines are now easing, allowing more tenants to return to the office. During the last few months, many in the technical and professional workforce worked effectively from a home-office environment.
With tools such as Zoom, BlueJeans, and Microsoft Teams, communication was maintained, and cloud-based file systems enhanced productivity. As a result, returning to the office is occurring as a measured and phased process. Many companies are offering employees the option of working from home through the end of the year.
As offices re-populate, companies and building owners are examining issues of social distancing, amenity packages, and interior design.
Technology companies that relied on closely spaced open work areas with coffee bars, buffet food service, and other social amenities will face significant changes, while the stodgy, traditional configurations (think major law firms) will benefit from the social distancing that was designed into their current layouts.
There will still be challenges related to conference room activities of staff meetings and depositions; these may become hybrid experiences with some participants present in person and others making a virtual appearance.
Landlords will be challenged in how they address the amenity needs of their tenants, especially on-site restaurants and retail shops. The focus in the short term will shift to providing visible expressions of personal hygiene: hand sanitizing stations; plexiglass barriers at security stations; controlling the number of people in elevators; and enforcing masks in common areas.
Long-term impacts
Office is the third hardest hit property category from the pandemic, behind hospitality and retail. It is also third from the bottom with regard to recovery from the recession.
Reduced demand for space will come from:
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- Less growth in the employment categories that generate office demand
- Companies having fewer employees, especially if staff members can be productive working from home
- Demand for some common area spaces (like staff lunch rooms) dropping off.
Offsetting some of this reduction is a possible need for companies to increase the square footage per employee for social distancing, but the long-term net effect is expected to be reduced overall demand.
Since most office tenants are subject to multi-year leases, impacts to long-term occupancy trends will appear gradually, as tenants use lease expirations to vacate their premises or negotiate to a downsized footprint.
Early signs, however, are already appearing. Some of the companies with the biggest growth over the last few years (Facebook, Opendoor, ZipRecruiter and Nationwide), have announced a combination of layoffs, furloughs, and transitioning to a work-from-home culture that will result in a significant decline in office space needs.
Concerns about future financial performance is causing challenges for office properties in purchases and other recapitalizations. Most potential buyers are staying on the sidelines, waiting for prices to drop.
Sellers are sitting tight, hoping that a re-opened economy will make this short recession. If that doesn’t happen quickly, there will be pressure from lenders and outside investors to force some sales at new, lower price points.
The office investment sector is facing a more segmented future. Buildings with strong credit tenants in growth industries will remain in high demand. Medical office will be fine, but properties with weaker tenant profiles are likely to suffer declines in value and long-term occupancy.
The prospect of falling occupancies and rent reductions will cause cap rates to rise, which will magnify any value declines.
Higher cap rates have not materialized yet, but that is something the industry is keeping a close eye on as investors evaluate the position of office properties in their portfolios
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About Beau Beach, MBA CCIM
Beau is a tenacious Commercial Real Estate Broker, author and adoring father of four. His clients appreciate his no-nonsense demeanor and his legendary work ethic.
Beau leads Beachwood which is a commercial real estate broker for sellers in the Nashville, Milwaukee and South Florida markets.
He’s the author of the books The 3 Reasons: Why Most Commercial Properties Don’t Sell and True Wealth: What Every Seller Should Know About 1031 Exchanges.
Beau can be reached at 800-721-3287, click to schedule a call or Beau@soldbybeachwood.com