A Blog by Jonathan Low

 

Apr 8, 2021

Businesses Keep Downtown Offices, But Demand Post Covid Rent and Space Cuts

Organizations want to hedge their bets on commercial real estate until they see how the post-pandemic recovery affects employees' return to work. 

But transaction data suggest they are not yet ready to abandon downtowns or the big offices that fill them. JL 

Peter Grant reports in the Wall Street Journal:

Big companies are making plans to stick with city-center office buildings, but they are cutting back on space and driving down rent prices for years to come. The U.S. office-vacancy rate rose to 11.9% in the first quarter compared with 9.7% at the end of 2019. Landlords are offering long-term leases of four and more years at discounts up to 13% below rent rates reached in the first quarter of 2020. Companies are also seeking on average 10% less space than in the first quarter of 2020. But companies are realizing that they might regret signing short-term leases because in a few years rents might rebound.

Big companies are making plans to stick with city-center office buildings, but they are cutting back on space and driving down rent prices for years to come, according to an analysis of U.S. office leasing trends prepared for The Wall Street Journal.

The Journal’s leasing information comes from the data firm VTS, which tracks tens of thousands of negotiations across the U.S. between landlords and tenants. Landlord and tenant discussions in seven of the largest office markets offer an early glimpse into the evolving workplace strategies for hundreds of companies after a year of largely remote work.


Rent proposals made during the first quarter suggest that many companies in the biggest markets—including New York, San Francisco, Chicago and Los Angeles—are embracing an emerging hybrid model: maintaining a shrunken office presence while allowing employees to work remotely at least part-time.

The terms under negotiation show landlords are offering long-term leases of four and more years at discounts up to 13% below rent rates reached in the first quarter of 2020 when factoring in concessions like periods of free rent, according to VTS. Companies are also seeking on average about 10% less space than they were looking for in the first quarter of 2020.

As Covid-19 vaccine rollouts accelerate and more workers feel that it is safe to go back to the office, more companies might look to add office space. But if the current tenor of negotiations persists, it would be setting up building owners for a challenging period.

The U.S. office-vacancy rate rose to 11.9% in the first quarter compared with 9.7% at the end of 2019, according to data firm CoStar. Now, landlords are willing to offer rent discounts just to keep the vacancy rate from climbing higher.

“It’s not good for landlords,” said Ryan Masiello, co-founder and chief strategy officer of VTS. “It’s more down time, lower rents, and they have to weather the storm.”


While the pandemic has helped ignite the hottest U.S. housing market in years, it has upended much of the commercial real-estate industry. Hotel owners furloughed workers, temporarily closed properties and have been running at low occupancy since reopening. Many malls have struggled to make mortgage payments and collect rents from ailing retailers. Co-working firms fired staff and some went under.

Office towers in the largest U.S. cities were considered a safer bet because their tenants signed long-term leases. And most office renters have continued to pay even during Covid-19. But now the building owners’ rent concessions will lock in lower revenue for many years. That in turn is likely to lower the value of their properties.

The VTS analysis does offer big landlords some encouragement: Most tenants in recent weeks are looking to sign long-term deals, rather than cutting ties in favor of full-time remote work or cheaper office locations outside city centers. That suggests many buildings could remain profitable even if their revenue takes a hit.

A steady stream of workers returning to the office would also be welcome news in the business districts of New York City, Chicago and other major cities, where retailers, food operators and other small businesses have suffered with their customers working at home rather than at the office.

Some landlords have been up-front about offering attractive concessions to close a deal. “We’re saying, ‘Take advantage of us,’” said Craig Deitelzweig, chief executive of Marx Realty Co., which owns about 5 million square feet of office space in New York and Washington, D.C.

According to the VTS analysis, 1,302 companies started searches for office space in the top seven markets in the first quarter. That represented a 40% drop-off in activity compared with the first quarter of 2020, when 2,171 tenants began searches.

But the number of tenants entering the market has started rising in recent weeks as the vaccination rollout progressed. In Seattle, for example, more than twice the number of tenants began searches in March compared with January.

“Six months ago we were doing one to two tours per week,” said Jesse Ottele, executive managing director of the Seattle office of commercial real-estate services firm Newmark Group Inc. “Now we’re doing one to two a day.”

Many businesses have said they wanted more office flexibility while they sort out how many people will work remotely and how often. But companies are realizing that they might regret signing short-term leases in this market because in a few years rents might rebound. “Guess what cycles do? They turn,” said Mary Ann Tighe, CBRE Group Inc.’s chief executive of the New York region.

More than 45% of the tenants who are negotiating with landlords want to make commitments of seven years or more, compared with 34% in 2019, according to VTS. Indeed, brokers report that some tenants who have a few years left on their leases are looking for space early to lock in attractive terms.

Landlords are also taking heart because scores of companies, including Amazon.com Inc. and Alphabet Inc.’s Google, have recently said they plan to return to the office later this year. Fears are easing that the popularity of working from home would convince many companies to give up most of their office space.

The tech sector is one of the few in which average space requirements being negotiated now are higher than what they were before Covid-19, according to VTS. “Tech demand dropped. But it’s back up again,” said Mr. Masiello.

Still, most companies are cutting back on office space. Loomis Sayles & Co., a Boston-based investment firm, signed a new lease in February for 230,000 square feet, one third of what the firm had been leasing previously, “We are…capitalizing on our ability to support more work from home,” Kevin Charleston, the firm’s chief executive, said in an email.

One fintech tenant that began looking for 20,000 square feet in the Miami area earlier this year scaled that requirement back to 12,000 square feet. That is because about half of workers have indicated in surveys they want to work from home part of the time, according to Donna Abood, head of the Miami office of Avison Young, which is representing the tenant.

New York and San Francisco office markets have been hit especially hard. Rents in deals currently being negotiated in those two cities are down an average of 9% and 8%, respectively, compared with leases executed in 2019, including rent and landlord concessions like months of free rent and interior work, according to VTS.

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