Futuristic, amenity-laden office spaces like Amazon's Spheres, in Seattle, lack only one thing: workers.
The battle to bring people back to the office is raging, and landlords are finding that only the highest-quality office buildings with slick interiors, modern amenities and access to outdoor space are gaining traction with tenants and workers.
|
U.S. employers gave 58% of workers the choice to work either fully remotely or in a hybrid arrangement for the first half of 2022, according to a recent McKinsey & Co. Inc. survey of 25,000 employed adults, and many employees have expressed limited desire to return to the office on a full-time basis.
"I've done a number of deals where tenants have either relocated or renewed on a smaller footprint than what they previously had under lease. And it's all driven by the uncertainty of the workplace," Chicago-based Avison Young principal Fred Ishler said in an interview.
Choppy waters
Prior to the pandemic, U.S. office leasing volumes were robust. About 58.3 million square feet of office space was leased in the fourth quarter of 2019, according to global real estate brokerage firm CBRE Group Inc. Widespread shutdowns and stay-at-home work policies in the second quarter of 2020 caused that figure to plummet by nearly half.
Vaccination rollouts, easing restrictions and stronger market confidence led to a surge in office leasing in 2021, eventually surpassing pre-pandemic leasing levels in the fourth quarter at 60.5 million square feet, CBRE found.
The rebound appears to be short-lived. U.S. office leasing volumes fell to 54.1 million square feet in the first quarter and dropped to 49.1 million square feet in the second quarter, according to CBRE.
Companies abruptly transitioned to remote or hybrid work during the pandemic and many have kept that flexibility. The McKinsey survey, conducted between March 15 and April 18, showed that 35% of U.S. employees can work fully remotely, while another 28% can work on a hybrid schedule.
Keeping them happy
Efforts over the past year to get employees to return to the office full time have widely fallen flat, and foot traffic in office buildings continues to linger below pre-pandemic levels. Some companies have been reluctant to force their employees to come back to the office, as a record number of workers continue to voluntarily leave their jobs in what has been dubbed the "great resignation." The result is a widespread reimagining of the workplace that has ominous implications for commercial real estate owners and investors.
"Challenges to the commercial real estate market posed by remote work and other factors have contributed to our forecast of outright declines in real gross investment in commercial structures through 2025," said Ben Herzon, economics director at S&P Global Market Intelligence.
In a recent 451 Research survey of about 600 information technology companies, 32% of respondents said labor and skill shortages pose the largest threat to sales, behind supply chain issues at 33%. Attrition was the biggest concern for companies that participated in the survey, and 35% of respondents said they are prioritizing retention over business expansion in 2022.
Forcing unwilling employees to give up remote or hybrid working arrangements could potentially limit those efforts.
"Even large companies making tons of money are more concerned with keeping employees happy and engaged than they are with growing the business for this year," 451 Research Senior Analyst Conner Forrest said in an interview.
Some companies are deciding to ditch unnecessary office space.
"We've seen anything from a 10% reduction [in square footage] to potentially as much as a 70% reduction, but most of it in that 25% to 30% range," Society of Industrial and Office Realtors Global President Patrick Sentner said in an interview.
Some large companies have opted to halt or pull back significantly on ambitious office expansion plans. Reports emerged in July that major technology firms Meta Platforms Inc. and Amazon.com Inc. have reduced the amount of new office space they planned to lease in Manhattan, N.Y. Amazon also paused construction on six new office buildings in Bellevue, Wash., and Nashville, Tenn., confirming that the pause was to reassess office needs in a world of hybrid work.
Commercial real estate research and advisory firm Green Street predicted that employers' rising acceptance of hybrid work, along with battles for talent and cost-cutting drives, will ultimately cause U.S. office demand to fall by 15%.
No upgrades, no interest
The flight to quality is not a new phenomenon in the office sector, but vast amounts of available direct and sublease spaces have accelerated the trend. Office brokers say that if landlords are not investing in glossy new upgrades for their buildings, tenants are not interested in signing new leases — or in renewing.
"Even if it's not designed to the highest nth degree, tenants want to see that a landlord is spending money on the building," Ishler said.
Tenant improvement allowances — rebates provided by landlords to build out or improve offices — have increased substantially since the pandemic began. Similar to shared spaces in a building, tenants use trendy offices to attract and retain high-quality talent.
In the first half of 2022, tenant improvement allowances for top-tier office buildings in 12 major U.S. office markets averaged $89.93 per square foot, up 11% from 2019, a recent CBRE analysis found.
"[Landlords] are putting more tenant improvement dollars into their proposals than they ever have in the past. However, in exchange, they are getting longer terms and higher rental rates," Sentner said.
The success of high-end, amenities-laden office buildings has not been restricted to downtown areas. Ishler focuses on office leasing in Chicago's suburban submarkets and said class A buildings in residential areas have enjoyed strong leasing activity and foot traffic.
"It is amazing, [in] the nicer suburban office buildings, how many more people are in the office ... than their counterparts in the central business districts," Ishler said.
Demand for certain types of amenities has also shifted. Before the pandemic, it was all about renovated lobbies and elevator banks, conference facilities, gyms and food options. Buildings still need those things, but tenants are now actively looking for properties with quality outdoor spaces where employees can relax and breathe fresh air.
"It has to be very programmable and flexible. People want Wi-Fi, they want upgraded seating areas, they want it to be proximate to food and coffee," Los Angeles-based Cushman & Wakefield PLC Executive Director Pete Collins said in an interview.
Workers are also prioritizing their children. A record number of women in the U.S. left the labor force during the pandemic due to the lack of convenient or affordable childcare options. Daycare facilities are still a rarity in office buildings across the U.S., but tenant demand has definitely risen, Sentner said.
"I've been doing this for 27 years, and it has probably only been the past year where I've seen and heard tenants specify that this is something that we absolutely have. And if we don't have it in the complex, it better be across the street, or very, very close in proximity to the office space," Sentner said.
The future is flexible
On average, office deals are taking three to six months longer than before the pandemic. Aside from the uncertainty surrounding hybrid work, supply chain issues have made it much harder for contractors to get building materials for fitting out tenant offices.
Brokers said leasing activity in the coming months will provide a much clearer picture of what employers are planning in the long term.
"Kids will be back in school [and] summer vacations are over. We're going to find out, are people really willing to come back into the office on a regular basis, and what does that look like?" Ishler said.
The looming prospect of a recession may force employers to make hard decisions regarding remote and hybrid policies, and what this means for their office footprint. If hiring slows, employers could regain some power in the labor market.
"Do I expect many companies to go back to the full five days? No, I think the recession would have to be really tough for that," Sentner said. "And even under that scenario, I still think there are going to be companies that are going to want to provide flexibility to their employees."
451 Research is part of S&P Global Market Intelligence.