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As Tenants Accelerate Office Return Plans, Investors See an Opportunity

Remote work was expected to devastate the office sector. But suddenly many firms are switching gears and pushing for the returns of workforces.

With vaccines demonstrating their effectiveness in reducing COVID-19 transmissions, hospitalizations and deaths, employers around the country are feeling more confident about asking their employees to start coming back to workplaces. During the depth of the pandemic, a number of companies either postponed their returns to the office until September 2021 at the earliest or announced that they would go fully remote. This trend toward a “remote work future” now appears to be reversing rapidly.

Within the past two weeks large U.S. employers, including Google, Amazon, Salesforce, Microsoft, Bloomberg, JP Morgan Chase, Citigroup and others, have announced they will start welcoming many office workers back months ahead of previously anticipated return dates. In some cases, such as at Google and Bloomberg, workers counting on the possibility of permanent remote work were met with news that it isn’t going to be a widely available option.

“Employers have lots to think about, but the narrative is changing favorably for the office sector as a result of vaccines,” says Dallas-based Jeff Eckert, president for U.S. agency leasing with real estate services firm JLL. Many larger companies have already announced plans to return to the office between July 4th and Labor Day, Eckert adds.

Faced with an exhausted workforce, shrinking networks, a need to mentor younger workers and the desire to protect their internal culture, many companies are seeking a balanced approach to the “in office” vs. “remote” options, even if they are adapting a hybrid work model, says Chase Bordelaise, managing director, consulting services, at real estate services firm Transwestern. “Many are finding the solution is a balanced, hybrid approach where employees work where they perform best,” he notes.

“As rollout of vaccines continues, employers will continue the balancing act to achieve a flexible, productive workforce,” says Liz Love, managing director, tenant advisory + workplace solutions, in Transwestern’s Atlanta office. Today, more employees are expressing a desire to work two or three days a week in the office, she notes. Nevertheless, creating a balance of remote and in-office workforces remains a long-term strategy for many corporate tenants due not only to some employees’ desire to work from home, but also to the potential cost savings that would come from the associated reduction in office space. In fact, according to the Bureau of Labor Statistics, there was a 35 percent decline in people working from home from May 2020 to March 2021

What does this mean for projections for office space demand? According to Andrew Matheny, research manager in Transwestern’s Dallas office, in the long term, it might mean a lot less of a change than has been forecasted during the depth of the pandemic and prior to the approval and distribution of vaccines. “The overall impacts to demand for office space will likely be marginal in most markets for one simple reason: companies that want to encourage employee collaboration will need to provide office space to accommodate them, regardless of how many days or hours they work remotely,” he says.

Eckert agrees. “Connection, communication and collaboration are vital to corporate America’s ecosystem so getting people together is critical. But employee safety and well-being is a top priority,” he says. That is why employers will likely continue to de-densify their office space and building owners will continue to invest capital to provide a healthy environment to tenants with improvements such as high-grade air ventilation and purification systems and operable windows, according to Eckert and Mark Zettl, president of JLL Property Management.

According to surveys conducted by JLL with occupier clients, 50 percent are planning permanent design changes—up from 10 percent earlier in the pandemic—with a plurality anticipating de-densification of their space.

“Generally speaking, tenants are planning to ‘gather and scatter,’” Zettl says explaining that this is the popular term for reallocation of space from individual workstations and offices to communal, collaborative spaces to accommodate a higher share of hybrid workers. “We’ve heard anecdotally that some tenants are shifting density targets from 150-200 square feet per person to more than 250 square feet and reallocating space from individual workstations to collaborative space and larger conference rooms.”

In addition to more space devoted to collaboration areas, other frequent workplace modifications currently include workstations that can be shared, some of which have privacy shields, focus pods and more flexible wall installations, according to Bordelaise.

Zettl also notes that many employers who want their workers back in the office realize that amenities will be a key driver in luring them back. That will include shared amenities, such as fitness centers and communal outdoor spaces, paired with concierge services, food and beverage space and on-site, as well as virtual, programming for connection. These trends, however, pre-date the pandemic, although it might end up accelerating their adaption.

Takeaways for investors

“The best news for office investors is that a return to the office will be accompanied by a return in demand for office space,” says Matheny. Commercial real estate lenders appear to share this view. Bloomberg reports that this year, about a third of all single-borrower CMBS loans—totaling roughly $4 billion—were backed by class-A office buildings in large urban city centers.

However, the drop in leasing transactions over the past year made price discovery for office buildings difficult, according to Matheny, leading to a drastic decline in office acquisitions. In February, office sales volume, at $2.8 billion, was down 77 percent compared to February 2020, according to real estate data firm Real Capital Analytics (RCA). Over the 12 months ending in February, office sales volume declined by 48 percent. In addition, as of February, office REITs, not retail or hospitality REITs, had posted the worst year-over-year performance in part due to concerns about the future of the sector. 

However, Matheny notes that business surveys and early signs from the Dallas office market point to a relatively fast recovery for the office sector compared to past recessions. That should also allow office investment to flourish again.

Both employers and real estate investors are betting that the office environment will continue to play an integral role in business operations over the long term, notes Bordelaise. It’s the near term that is still unclear. “Many buildings will explore a flexible office portion within their building stack, which may impact valuations,” Bordelaise says, noting that investors will pay careful attention to how employees—the real consumers of office space—will “vote with their feet” over the next 12 to 24 months.

Bruce Miller, senior managing director for capital markets with JLL, remains optimistic about the return of office investment activity. He notes that the recent downturn in investor demand is the result of some investors feeling the cycle, which had lasted over a decade. But the biggest obstacle to investment over the past year was that the pandemic obscured major assumptions that go into valuing an office building, including rent growth prospects, the volume of tenant downsizing that might occur, and length-of-time to fill vacancies and get to stabilization, Miller says.

Today, the factors that are creating in him a sense of optimism are multi-faceted. They include the increases in vaccination rates; the moving up of many companies’ return-to-office dates and the frustration of investors who are trying to invest in industrial, multifamily and other highly sought-after property types and are faced with the prospect of very compressed returns compared to those they can achieve by investing in stabilized office properties. In February, cap rates on sales of office buildings averaged 6.6 percent, according to RCA, compared to 5.0 percent for multifamily properties and 5.9 percent for industrial facilities.

Additionally, Miller contends that the federal stimulus package, coupled with President Biden’s proposed infrastructure improvement program, should create significant economic growth that would translates to more office jobs and increased demand for office space. “We already have economists predicting 5 to 7 percent GDP growth in the latter part of this year,” he says.

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