By the Numbers Office

Checking on the Recovery

Dismissing the coming structural changes in the office sector would be naïve — but so would signing the sector’s death certificate. While work from home has proven adequate in many ways, the path forward is likely to be a simple expansion of the pre-pandemic hybrid model. This in no way excludes the office sector from current and future space and capital market stress, but balance and nuance are required in the discussion.

Given the long-term lease nature in the office sector, it is not surprising that 2020 rent and vacancy trends were mostly stable; recessionary lags of six to 18 months are typical. During the year, U.S. effective rent levels declined 0.6 percent, while the vacancy rate increased 100 basis points to finish the year at 17.8 percent. Given the traditional lag, the direct consequence of the economic strife is likely to hit later in 2021. As shown in the chart, effective rents are expected to fall another 7.6 percent, with vacancy reaching nearly 20 percent by the end of 2021.

BTN Spring 2021 Chart

Moving forward, the sector’s recovery is unlikely to be V-shaped — a check mark may be more appropriate. Many firms are pausing expansion plans related to office space, and more than a few will feel a reduction is warranted. This great work-from-home experiment has showed employers that certain tasks can be completed without constant in-person supervision. Due to this, the percent of traditional office labor working from home at least one day a week is likely to double from its pre-pandemic levels and top 40 percent in the near future.

While the hybrid model is certainly primed to expand to more firms and employees, the increase in fully remote jobs will be more muted and reserved for less creative occupations and tasks. Innovation needs interaction. Economics teaches us that informal communication may be as important for the generation of new and valuable ideas than its formal and planned counterpart. Without the watercooler, future productivity suffers. In March 2020, when most office workers were sent home, much of the rest of their year was already planned. In that circumstance, human nature allows us to bear down and complete those tasks with efficiency. But how many great new ideas were lost due to the lack of an office presence? It is this line of thinking that will prevent a more significant structural change in where we work and will also prop up the office sector moving forward.

Additionally, GDP growth is likely to hit 5 percent each year for the next two years and will continue to be above its long-run average for a short time thereafter. This bullish economic outlook is shared by many firms, prompting them to increase their mid- to long-run growth prospects. Even in the face of a new hybrid work situation, this trend will necessitate an increase in square footage. The recent leasing activity of tech giants Facebook, Apple, and Amazon, who have grown through the pandemic, provide evidence of this phenomenon.

BTN Spring Chart 2b

All this said, the recovery is unlikely to be uniform. The charts shown here illustrate the rent level difference from 2019 to its projected 2023 level. While not a “death to density” situation, there is a bit of a difference in which areas are able to recover faster. California’s Bay Area, greater New York, and greater Los Angeles — all dense areas with expensive office sector real estate — will find a return to pre-pandemic rent levels a bit more difficult. But these areas historically have much greater variation in rents due to less flexibility in their development markets.

There are also a few anecdotes and some data to support that some firms may be diversifying away from the more expensive central business districts and finding satellite space in either the suburbs or less expensive metropolitan areas. These findings are very preliminary, though, and this data includes a lot of noise.

To conclude, the worst is yet to come for the office sector, but it’s not predicted that this situation will be equivalent to e-commerce’s assault on brick-and-mortar retail. Firms are still finalizing their post-pandemic office space needs. Some firms may renew with less space as leases expire, and others may even move to a new location within or outside of the current metro. Rent levels in New York and San Francisco will remain below their pre-pandemic levels until later this decade, but it is expected that tech firms, both established and startups, will take advantage of the discount, ushering in a new generation of talent into those respective cities. Long story short, the office is not dead.

The worst is yet to come for the office sector, but it’s not predicted that this situation will be equivalent to e-commerce’s assault on brick-and-mortar retail.

What about the capital markets? To blame the decline in activity wholly on the economy would be imprudent. Mandatoe once again reach full employment (doubtful anytime in the next year or so), we will see further stress on B/C properties. 

Thomas P. LaSalvia, Ph.D.

Senior economist at Moody's Analytics Reis.

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