As the human toll of the coronavirus pandemic has mounted, companies have limited non-essential business travel and told employees to work from home. The effect on cities has been profound, and unsettling, with a cityscape characterized by empty office buildings, quiet streets and shuttered stores.
Middle market companies have shown that they can shift from a traditional brick-and-mortar setting to a virtual one.
Now, as many middle market companies have shown that they can shift from a traditional brick-and-mortar setting to a virtual one, office building tenants, and landlords, are rethinking the need for offices in the future — and the related fixed costs they bring.
The issue
The pandemic has served as a beta, of sorts, to test the capabilities of computing networks in handling a broad-based work-from-home population for companies across the country.
A significant increase in employees working remotely in a short period of time has caused an “ah-ha” moment for many workers who have cut their commute time, been just as productive at home and spent more time with their families.
The real question is: Will this be a longer-term shift of preferences for larger scale mobile workforces? The answer could have a profound impact on the demand for office space and other real estate.
What we know
In a survey of executives for RSM’s proprietary Middle Market Business Index for the second quarter, executives across sectors said that at least some employees who were forced to work remotely will not have a reason to return to the office once the pandemic subsides. Additionally, within each segment, at least 10% were not sure what the future of their office looks like.
The results were based on a random survey of 416 senior executives, conducted from April 8 to April 23, including respondents in manufacturing, retail, technology and fintech.
While the full impact of the coronavirus on the office sector is yet to be seen, we do know that leasing activity and transaction volume in the sector has fallen off a cliff on the demand side.
Decision makers are putting off major investment decisions like entering into a long-term lease that becomes a fixed cost for a company facing so much uncertainty.
Decision makers are putting off major investment decisions like entering into a long-term lease.
On the supply side, CoStar data shows that across the United States there is roughly 160 million square feet of office space under construction, with most concentrations in tech hubs such as Austin, San Jose, San Francisco and Seattle.
This pipeline represents about 2% of the office stock nationally. Even before the coronavirus, new projects coming online were slowing the rate of office absorption nationally, and rent growth had been decelerating as a result. Now, with COVID-19 spreading, these trends are accelerating.
Adding to headwinds facing the office sector are continued densification, a trend that won’t likely reverse as more employees are able to work remotely, and shifting demographics as boomers age out of the workforce with the much smaller population of millennials and Generation Z showing up at work.
The further potential downshift in the office sector spurred by the coronavirus will drive overall uncertainty in the sector, which may halt companies’ significant leasing decisions until certainty replaces panic in the marketplace.
The future
Even in a future with smaller physical office footprints, the computing power necessary for a fully functional mobile workforce will result in increased demand for data centers. These centers will need to support technologies including teleconferencing and web conferencing, and work-from-home capabilities enabled by cloud computing.
Another play for real estate? Infrastructure-focused investments, telecom towers and wireless infrastructure, which stand to benefit from the shift from working in brick-and-mortar office spaces to remote locations. Investors with significant co-working exposure in their portfolios may be affected by a decline in short-term rentals as companies looking for flex space may forgo communal space centered in the middle of an outbreak.
The case for the office
Many things that seem inconceivable during a crisis are softened with time. Our collective memories are pretty short. Take, for example, the 9/11 attacks – there was a time when many recoiled at the thought of taking office space on high floors in skyscrapers. Nearly 20 years later, the most expensive office real estate around the world before the coronavirus continued to be in densely populated cities, in skyscrapers.
At a minimum, landlords and tenants need to evaluate how they manage people flow and tracing within their buildings. This base-level tracking is going to be imperative to reassure tenants that precautions are being taken to limit exposure, and if there is exposure that there is sufficient tracing to be able to notify all those exposed.
The ability to provide a system that is effective and secure, and meets privacy protocols will be a challenge for every company and landlord trying to be back to work. Still, while there will almost certainly be a shift in what the “next normal” looks like in office buildings, people have an innate want to meet and gather as a community. This is how many of the best companies have built their cultures and attracted, and kept, top talent.
The takeaway
What is certain is that long-term fixed leases may be a thing of the past as companies facing greater uncertainties look for increased flexibility. After all, who can plan for a pandemic? Expect to see shorter leases, and more creative terms.
Read the full second quarter MMBI Q2 report, and visit RSM’s Coronavirus Resource Center.
