The full brunt of the pandemic’s toll on the office sector was evident at the end of the second quarter of 2020. The quarter ended with negative absorption of 21.5 million sq. ft., which is similar to the 21.2 million sq. ft. of negative absorption in the second quarter of 2009, according to the second quarter office report from real estate services firm CBRE.
Total office leasing dropped by 44 percent year-over-year and vacancy rose to 13 percent nationally. As tenants downsized, the percentage of sublease space increased by 30 basis points from the first quarter to its highest level since 2010, to comprise 2.7 percent of all available office space.
The majority of the quarter’s negative absorption, 72 percent, occurred in California, Texas and the New York metro area, which together include 43 percent of the nation’s office inventory, according to CBRE. The only markets recording positive absorption were in the Southeast, Midwest and Washington, D.C.
Despite all this, however, average asking rent rose to $35.54 per sq. ft., up 30 basis points from the first quarter of the year and 3.7 percent from the same period in 2019.
In the following Q&A, Chuck Schreiber, co-founder and CEO of KBS, a Southern California-based commercial real estate firm that acquires and manages class-A and trophy office assets in core and key secondary markets nationally, discusses the impact of the pandemic on the office sector, how that is changing tenant needs, and what that means for office owners going forward.
This Q&A has been edited for style and clarity.
NREI: From your perspective, what is the overall condition of the office market nationally?
Chuck Schreiber: The office market has historically shown strong resiliency and continues to do so throughout the COVID-19 pandemic. Judging by KBS’ own portfolio, we believe that well-amenitized office space, situated in prime locations in key markets throughout the nation [is] perennially in demand by office users. While office vacancy has fluctuated somewhat during this crisis as landlords and tenants adjust to new safety requirements, the virus has placed the responsibility of keeping employees safe and healthy on building owners and tenants. As a result, there’s evidence that companies may be using more space in the next year to de-densify offices in order to comply with social distancing mandates.
NREI: Has the pandemic altered the office market in ways that are permanent?
Chuck Schreiber: Health and wellness in the workplace will remain an ongoing priority. Before the pandemic, there had been a rising focus on health and wellness for office occupants in terms of reduced off-gassing from construction materials and furnishings; increasing natural lighting; and providing access to healthy on-site amenities, such as fitness centers and fresh, healthy food options.
Now, we have the added element of preventing viral transmission, which is being achieved through changing office layouts; increased sanitation; installing barriers like plexiglass between workstations; adding antibacterial surfaces, like copper; erecting signage aimed at reducing crowding; and installing touchless technology to operate equipment in common areas, like elevators and appliances. This additional layer is expected to be a part of office development and operation for the foreseeable future.
NREI: Which changes in the office workplace are temporary and will disappear if a vaccine is available?
Chuck Schreiber: If a successful vaccine becomes available, some of the precautions we are taking now to prevent viral transmission may not be necessary, such as mask wearing and strict adherence to social distancing. However, other measures we have implemented in the workplace are likely to be ongoing: why wouldn’t we want less touching of commonly used surfaces and office layouts that reduce the spread of germs, especially during cold and flu season?
NREI: What office trends have been initiated or accelerated by the pandemic?
Chuck Schreiber: In addition to accelerating the health and wellness trend, the pandemic has forced us to look even more closely at how tenants use office space, so that we may provide them with space that best suits their needs. Amenities, which began to grow in importance after the Great Recession, continue to be highly significant as companies look to recruit and retain top talent, and we have learned that amenities must be customized to the building and its location.
For example, at KBS’ Meier & Frank Building, a class-A office property in Portland, Oregon, we installed a bike storage facility equipped with 200 bike parking spaces, lockers, and drying closets—ventilated compartments designed to dry clothing throughout the day. Given Portland’s frequent rainy weather, this facility is a desirable amenity. It’s this type of thoughtfulness about amenities that will remain a focus for office owners looking to maximize their properties’ appeal and attract tenants.
NREI: What type of office markets nationally are most likely to do best in the current environment and why?
Chuck Schreiber: Companies will continue to be drawn to live/work/play CBDs in markets with strong population and economic growth and access to accredited universities. These are the markets that attract top talent and enable companies to build strong teams and remain competitive for the long term. KBS continues to keep a close eye on emerging markets in order to align our client portfolios with current trends in the office sector throughout the country.
NREI: What type of office assets are most likely to survive post-COVID-19?
Chuck Schreiber: Office owners who are aware of market trends and sensitive to tenants’ needs and desires will be better positioned to have well-performing assets in their portfolio. It’s a matter of being flexible, open to change, and willing to work with tenants to provide them with what they need and want in an office space.
For example, KBS recently began a partnership with Maptician, a cloud-based, workplace management platform that utilizes technology and data to reconfigure office and community spaces so that tenants can return to their workplaces in an organized and safety-conscious manner. This lets tenants know that we prioritize their well-being and will help provide them solutions to reopening their offices safely. It is this type of proactive approach that will distinguish successful office assets as we emerge from the pandemic.
NREI: Of the large core office markets, which ones are suffering the most and why?
Chuck Schreiber: Markets like New York City and Los Angeles that were hit hard during the pandemic have some challenges ahead of them, but they are not insurmountable. As long as these cities work with companies and incentivize them to stay, there is every reason to believe their office markets will recover quickly as the economy bounces back, which will boost market economies and encourage faster recovery. We also believe there will be opportunities for investors to acquire highly appealing, distressed real estate.
NREI: What is your forecast for the office sector in terms of both occupancy and investment trends through the rest of 2020 and beyond?
Chuck Schreiber: Since investment and occupancy in the office sector differ greatly depending upon location, KBS evaluates properties and markets on a case-by-case basis. Some markets will emerge relatively unscathed by economic uncertainty due to COVID-19, while others will have greater challenges.
Although some investors will remain on the sidelines for the rest of the year, some will see opportunities to purchase properties that are positioned to perform strongly once the pandemic subsides. We must remember that the current volume drop in the market is due to a forced closure, not market fundamentals. As such, we believe the office sector is poised to recover quickly in terms of both investment and occupancy once that closure is no longer an obstacle.
NREI: Some experts say tenants will reduce their office footprints over time due to greater flexibility in the way people work, while others say they will increase footprints to accommodate social distancing. What are you seeing actually happen?
Chuck Schreiber: We are seeing tenants adjusting their footprints to meet their particular needs. In many cases, companies are increasing their footprints as a result of rising square footage requirements per employee. While in the past, tenants may have allotted 85 to100 square feet per employee, now we may see this number as much as doubling to 170 to 200 square feet per employee. Companies also seem to be seeking a hub-and-spoke solution to their space needs, keeping office space in CBDs and leasing additional space nearby in order to allow for social distancing that houses their entire organization safely.
NREI: What do you think the average office workplace will look like two to five years from now, and how will tenants most likely use the office space they occupy?
Chuck Schreiber: It’s likely that workplace trends that promote occupant health and a seamless combination of remote and on-site office attendance are here to stay. While technology has enabled people to work from virtually anywhere, a recent Gensler study shows that the overwhelming majority of office workers still prefer to have an office to go to at least some of the time, so offices are not going away.
Workstation configurations that face employees away from each other and/or provide barriers to reduce the spread of pathogens are also likely to remain with us, along with modern methods of disinfection, such as the use of UV light to kill viruses and bacteria, will be ubiquitous. Technology and innovation will continue to provide new ways to keep people healthy, safe, productive, and happy in their workplaces well into the future.
NREI: What office trends have been initiated or accelerated by the pandemic?
Chuck Schreiber: Some of the office use trends we see accelerated by the COVID-19 outbreak include utilizing office space to collaborate and innovate. Only now with new protocols in place to reduce the risk of viral transmission, there is a heightened focus on wellness in the workplace and an increased emphasis on company branding and culture to unite employees who may be working from multiple locations.
NREI: What are the greatest challenges office owner/operators face post-COVID-19?
Chuck Schreiber: Going forward, we are likely see an influx in demand by tenants to expand or increase their office space to provide adequate room for social distancing so their employees feel safe and comfortable returning to the office. The challenge for many office owners over the next six months is going to be in meeting this demand for space. Most of our office buildings are almost fully leased. So similar to KBS, meeting tenants’ need for increased space will be a focus for many office landlords and owners.