• Office Brokers Don't Expect a Return to Normal Anytime Soon

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    Office Brokers Don’t Expect a Return to Normal Any Time Soon

    While brokers don’t believe the office is going away, they expect the challenges presented by the pandemic to last into next year.
     

    The office sector remains in a tough spot. The pace of workers’ return to offices varies tremendously across the country at the COVID-19 pandemic remains far from contained in multiple states. There are big questions as to what the density of office spaces will look like in the long term and how many jobs might be permanently shifted to work-from-home positions. Throw in increased political volatility, marked by ongoing anti-racist protests around the country, and it’s a difficult moment to be an office broker.

    “Civil unrest and politics, coupled with COVID-19, bring unknowns into the equation on economic rebound after a global shutdown,” says Robert Cleary, Boston-based senior vice president specializing in the office sector with real estate services firm Colliers International. Cleary was a participant in a recent survey released by the Society of Industrial and Office Realtors (SIOR). The sentiment survey for the first quarter of 2020 showed that its office index fell by 29 percent compared to the year-ago period. The index looks at indicators of investment sales, leasing and development activity, based on a survey of SIOR members. Office brokers throughout the country note that there is still a lot of uncertainty about what the office sector will look like after COVID-19, although leasing and investment sales activity are already slowly coming back in some areas.

    Cleary has closed a few leasing deals since March, but he adds that he has seen rent discounts of between 10 and 13 percent after COVID-19 hit. During the last three down cycles, rents ended up dropping by nearly 20 percent, he notes.

    On the acquisition side, “Most active downtown deals have put on the breaks to slow down and possibly realize better value,” Cleary says. “Unless money is hard, many investors pulled back since March. And, at the moment, the bid/ask gap is too wide, so there’s not a large seller pool in this climate.”

    In the short term, cash is king, and investors who have it may find some attractive acquisition opportunities, particularly in the suburban office markets, he adds. In the long term, Cleary expects both Boston’s urban and suburban office assets to remain a stable and sound investment. “Boston’s diverse economy, FIRE and TAMI (technology, advertising, media and information) tenants, superior higher education and talent pool will keep both urban and suburban office markets in favor with domestic and foreign money.”

    Elsewhere in the Northeast, the Manhattan office market may not begin to recover from the COVID-19 lockdown until 2022, according to Manhattan-based Jonathan Stravutz, of SDB-BIOC Commercial. Stravutz expects that office tenants will rotate employees between working from home and the office, so that only 30 percent of office space will be occupied at any one time. This is likely to continue through the end of this year and the next, unless a vaccine becomes available, he adds.

    “If only 30 percent of buildings are occupied that means 70 percent are vacant,” he notes, pointing to the enormous amount of co-working space that is now vacant and will have to be reconfigured before it can be occupied.

    As a result, Stravutz expects to see a lot of sublet space come to market, in addition to space givebacks and reductions in rental rates. Office tenants are beginning to leverage their newfound advantage to negotiate exceptional deals, he notes—one example is TikTok, which signed a deal in May for 230,000 sq. ft. in Times Square.

    Like Cleary, Stravutz also expects that more office tenants might move to the suburbs, setting up satellite offices in suburban communities where there are high concentrations of their employees.  As a result, they might eventually downsize their Manhattan offices, using them primarily for meetings, marketing or sales.

    Brokers from large firms and networks in the Central, Great Lakes and Northwest regions expressed a low level of confidence in their local markets in the SIOR survey. 

    Christopher Wally, an independent broker and principal at Wally & Company, based in Overland, Kansas, says that since March office leasing has ground to a halt, and investment sales have been hurt. Some transactions have been canceled. Of those still active, one-third are on schedule, another third remain on hold and the rest are delayed.

    “We’re going through a period when showing space to tenants is difficult,” Wally says, noting that in the early stages of the quarantine owners forbid people to enter their buildings.

    Now landlords have implemented temperature checks and other safety measures at entrance, but most tenants are continuing to work from home, he notes. Wally’s tenant clients have surveyed their employees, and two-thirds say they are not comfortable returning to the office yet or can’t come back because there are no open daycare centers or summer camps for their children.

    “Employers are inviting their employees back, but not requiring it, so I think the return to the office will be gradual,” he notes, predicting that office occupancy will be minimal until at least after Labor Day.

    Office occupiers may increase flexible work options and temper some demand for office space going forward, Wally says. But he adds that de-densification of office space will offset any increase in remote working options, as employers allocate more space per employee to accommodate social distancing protocols.

    In the short term, Wally says, “I don’t see major space givebacks, as the average lease term is seven years, and only 14 to 15 percent of tenant leases mature at the same time.”

    He also expects office users to decentralize employees, opening offices in the suburbs, in areas where employees are more comfortable driving their cars to work rather than riding trains or buses into downtown. In addition, entering a three- to six-story suburban office building makes more sense in a social distancing environment when high-rise office buildings are only allowing one to four occupants in an elevator at one time.

    According to the May SIOR survey, Western and Northwestern office brokers also continue to have a very low confidence level, despite a jump in confidence in the Northwest from the previous month, from 4.8 to 5.5.

    Phoenix-based James Lieberthal, associate broker at the independent brokerage firm Cutler Commercial, says that during the first few weeks of the quarantine “the market stopped in its tracks, and I lost nine of out 12 deals I was working on.”

    After a couple of weeks, however, the market started picking up again. On the office side, landlords negotiated rent relief with tenants, offering them a few months at a reduced rate or rent deferral, with paybacks over six months or the option of tacking the paybacks onto the lease terms.

    While the pandemic’s impact on the office sector has been severe, Lieberthal did close a $1-million office lease at Scottsdale Airpark five days into the lockdown. He notes that the tenant decided to move forward because the location was perfect, and the tenant felt it was a good deal.

    Going forward, there are two potential scenarios for the office sector, according to San Diego-based Dennis Hearst, senior vice president in the advisory and transactions services group with CBRE. Hearst specializes in representing law firms, corporate tenants and build-to-suit deals. He notes that office-using industries have been less vulnerable to COVID-19-related job losses than other sectors of the economy due to the possibility of remote working.

    And although some additional office job losses are expected in the second quarter, employment data confirms that the unusually high number of job losses classified as “temporary” would lead to a rebound in employment if the economy improves in the second half of 2020, Hearst says.

    But while some office workers are clamoring for a return to the office, others appear skeptical, he notes. “Most occupiers are evaluating their current and future space needs to support both an increasingly remote workforce and less office density for health and safety reasons.”

    Either way, Hearst remains optimistic. “The unmatched value of a dedicated space for commercial innovation and professional collaboration will endure, even if some long-term design changes occur,” he says.