2020 was expected to be a pretty good economic year for businesses. Enter Coronavirus. Now the economic conditions are uncertain as governments and businesses struggle with how to operate effectively during the pandemic. In the office space sector, demand is expected to decrease due to COVID-19 and the economic slowdown. We expect these factors will lead to more favorable office leasing conditions for office space users for the next several years.
COVID-19 is highly contagious. Businesses don’t want their employees getting sick at work and employees don’t want to get sick. As such, both employers and employees are generally content to have employees work remotely from home when feasible. This teleworking arrangement appears to be working fine for companies so far, with many reporting no reductions in employee productivity. Many businesses have already announced they will continue teleworking for some employees even after the pandemic has passed, leading to a structural reduced demand for office space in the longer term. However, social distancing within offices will offset some of this reduced demand as corporate space occupiers will be increasing per square foot allocation per employee versus the allocations used immediately prior to the pandemic.
Office space absorption is also directly correlated with job growth. If job growth is stymied by the pandemic, office space demand will be low. It is true that some business segments have been performing well despite the pandemic, but the global economy is slowing and many industries are contracting or failing altogether. This is especially true of the restaurant, hospitality, retail, and entertainment business segments. These sectors will ultimately impact the office market adversely as well.
While overall office space demand will be reduced due to the pandemic, many businesses located in large downtown areas are considering relocation to the suburbs because of employee safety concerns. The scope of this exodus remains to be seen, but could lead to slightly or moderately lower vacancy rates in the suburbs as compared with downtown districts in certain cities where civil unrest has occurred.
Cities such as New York and San Francisco have already experienced negative office space absorption over the past twelve months of -4.6 million square feet and -3 million square feet respectively. Cities that depend on energy business employment have also suffered negative absorption, such as Denver (-1.9 million square feet) and Houston (-2.2 million square feet). It isn’t all negative, though. Some cities have experienced positive absorption over the past year, such as Phoenix (1.7 million square feet), Seattle (3.6 million square feet) and San Jose (1.7 million square feet).
Over 160 million square feet of office space is under construction in the United States. Much of this space was pre-leased to tenants prior to construction commencing. However, leasing will be slow and these new projects will increase the overall vacancy rate when they are completed in the next 24 months. In some cases, the pre-leased spaces might be marketed for sublease instead of the tenant occupying the space.
It is possible that we will see an overall office vacancy rate near 20% in some cities in the next three years – which is at or close to the level of the early 1990’s real estate recession. That is what we call a “tenant’s market”. Tenants will have the opportunity to obtain lower rental rates and other concessions from landlords, dramatically reducing their occupancy costs. There will also be sublease opportunities priced at a fraction of today’s market rental rates. In some cases, there will also be good opportunities to purchase office properties at a discount. For tenants that do not have leases expiring in the next two years, there still might be an opportunity to renegotiate a lease. To take full advantage of a tenant’s market, a tenant should retain an experienced, exclusive tenant rep advisor to be certain they are presented with all of the space options available in their market and obtain the best overall lease value available.
While office space occupiers will have difficulties while the pandemic continues, some relief in office space costs is anticipated to be available in the coming years. Contact your ITRA Global representative for more information about how your company can capitalize on the changing office market conditions during these unprecedented times.
