CORPORATE OFFICE PERSPECTIVES | OCTOBER 1, 2020
Issue 242
The corporate consensus that I am hearing and reading is that by mid-2022 business and humanity will begin towards a new normal, while tens and hundreds of millions of folks will be taking their first and second rounds of vaccination. Most of us will still be wearing masks and socially distancing. There will be a significant portion of the population who won’t take a vaccine and this will be part of our delay towards normality. Corporations need to consider how much of their workforce will be remote during these next 12 – 24 months of transition time, how will they adjust their office facility layouts, knowing changes will be temporary, and what significant long-term changes has Covid-19 made to the way we do business. I personally don’t think we will ever return to the pre-Covid normality, but it will be a different normality. It may still be a terrific experience and there will be new restaurants and retailers filling all the vacancies the estimated 30% closure rate will create. Long-term, 10-15% or more of our workforce will be permanently working from home, and we are already seeing huge migrations of tech and other workers leaving high-cost regions for more affordable places to live. We will be hugging relatives again, but the life expectancy of the business handshake is still uncertain!
On the day Pinterest announced paying $89.5 million dollars to cancel a 490,000 square foot office lease, they had previously signed for a project that was going to be built in San Francisco’s South of Market. Due to a change of where employees would be located, developer Jay Paul announced it is going ahead with a 3.6 million square foot office project in Downtown San Jose. There will be three 19-story towers and it will be located a few blocks away from Google’s planned 8 million square foot project. So on the one hand negative news affecting the office market, while at the same time a very strong faith in the long-term value of office space.
A number of regions are reporting an avalanche of new office sublease space. I was on an SIOR national broker call and my associate in Dallas, Texas said they had 4.6 million square feet of new office sublease space come on the market in just the past three months. She reported that in one day over 200,000 square feet of sublease space hit the market. In New York as of July 28, 2020 there was 14 million square feet of office sublease space, making up 25% of all available space. San Francisco has over 5 million square feet of office sublease space, and this trend is happening in major cities across the country. Smaller cities in some cases report limited excess space, so I am not sure if this is just a factor in the big towns. Companies for the most part have not returned to the office, and in many cases are allowing employees to work from home now and into the future. In almost all cases the tenant trying to sublease is keeping their rent current and is not in default, which protects the landlord, but at some point, their lease will expire and the vacant space will then return back to the landlord. Is it possible we may have a tsunami of future office foreclosures when this occurs?
I attended a webinar a few weeks ago with office specialists from JLL, C&W, Cresa and Newmark Knight Frank, representing San Francisco, the Peninsula, the East Bay and Silicon Valley. When March hit, the world just stopped in San Francisco for the most part. Nothing was happening, and tenants only did what they had to do. Along the Peninsula, there were still lab deals moving forward, as it is hard to be a lab worker working from home. In the South Bay, R&D was still doing deals, although down 50% from the previous year, but not as bad as the office market which was down 64%. Much of the leasing activity everywhere was lease renewals. There seemed to be many doing 1-year short-term extensions so companies could see when their employees would actually come back to the office, how long the pandemic would last, and what the long-term impact might be. San Francisco reported an increase of 2 million square feet of office sublease just during the past few months. More direct space is anticipated to come back to market as leases expire. One broker commented that the invitation to come back to work will for the most part be up to the employee to decide, as companies do not want to force a return to the office during the pandemic. There was also a great comment that having employees in a physical space is great for recruiting and getting new employees into the company work culture, which can be difficult to do working from home. With 10-20% annual turnover this could be a deciding factor in the future. Another suggestion was installing UV lighting in stairwells that were going to be used to get up to your floor, so you do not have to take the elevator. Tenants may be asking landlords about HVAC system specifications, how many times the air is turned over, what the landlord is doing regarding filters, UV, ionization, etc., basically issues that were not previously on the corporate radar screen. Lastly, the jury is still out if headquarters need to remain the same size, will some operations move to the suburbs, and will less space long-term be needed if more employees, again long-term, work 2-3 days a week from home?
There has been a lot of hype on the world getting a vaccine in late 2020 or early 2021 and then life will return to normal. However, when one of the smartest and largest corporations in the world announces a year in advance that Google will let employees work from home until at least July 2021 leads me to believe we will be in this mess much longer than most of us had been planning for. I expect other tech companies to follow suit, but what does this mean for corporate America and planning for office lease renewals and relocations? Back in 2018, just in the Bay Area Google had 19.9 million square feet of office space, with millions and millions more in its other offices around the world, so this is an expensive decision and one that puts its employees first.
Something for employers to caution employees who are thinking of temporarily moving to a lower-cost state and continuing to work remotely is this: In an article in the New York Times, there are some states that will tax your income based on where you did the work, and others based on your residence, and it is possible you will owe taxes to both states for the same income. Some states have reciprocity but not all states. Of course, check with your CPA!
It was expected by many in the office industry that with the pandemic, now in its 8th month, occupancy levels would be in the 25-50% range. But several national landlords are reporting occupancy rates much lower. “Oxford Properties U.S. Head Office Chris Mundy said his firm had initially expected buildings would reach around 25% occupancy soon after the reopening process began and then gradually increase. “The realty has been much different, he said, with Oxford’s U.S. office portfolio today still at less than 5% capacity.” ”Ivanhoe Cambridge Executive Vice President Jonathan Pearce, with a 130 million square foot portfolio, said “The longer-term implications of talent management, of loyalty of staff, of turnover, of feeling burnt out and feeding into the mental health issues, I think those things are immeasurably linked and are much more complex than just turn the lights on, everyone goes back to work, and pretend that nothing happened.” Doug Fleit, CEO with American Real Estate Partners, said “We need to figure how we’re going to come back to the office and have collaborative spaces, use the fitness, figure how we’re going to be fed in the office. All the things we’ve worked to develop the last 20 years to the level that we have, we shouldn’t lose over the next five years. We need to come up with better solutions than 6 feet apart and Plexiglas cubicles. That’s not the right solution.” (Bisnow July 24, 2020)
www.bisnow.com reported today that New York City brokers do not feel very confident in the current and future state of the real estate market, and in a Real Estate Board of New York Broker Confidence report released yesterday averaged 1.94 out of 10 this quarter. “In their general written comments about the market, brokers cited ‘declines in disposable income” and “the inability to cold call” as reasons for their rating.” Their market is moving again, with increased investment sales up fivefold from May to June, but still down 55% year over year. I have been on Zoom networking meetings with my peers from around the country, and the overall sentiment is much more positive. I have associates in Texas and other states who are still doing deals, some in the health care industry with almost more business than they can handle, but across the board business is way down as compared with any point in 2019.
Rich Commercial Realty in Raleigh, North Carolina recently had a survey of thousands of their clients, vendors and contacts asking about the current usage of office space. 69% reported currently occupying their space, and of those who hadn’t yet occupied their space and were asked when they would do so, 25% said the next three months, 13% said the next six months, and 62% weren’t sure. 86% had employees working from home full-time, with 14% reporting this would be permanent and 86% saying it was only temporarily.
In my morning paper a few weeks ago, the headline read “249 experts agree: Virus lingers in the air indoors”. This got me to thinking how safe are office spaces in today’s pandemic environment? Asia has been repopulating many of its corporate office’s months before the U.S. and I couldn’t find any reports one way or the other. There are a number of published recommendations for improving the air quality in office buildings, including increasing the percentage of outdoor air into the system if possible, opening windows if available, increasing the airflow supply to occupied spaces, running the HVAC system after-hours to improve air dilution (that will run havoc with your operating expense budget), using ultraviolet germicidal irradiation as a supplement to help inactivate the virus, and numerous other ideas. The American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) has a ton of recommendations on their website. Some of their ideas might dramatically increase utility costs, so be aware. Government at different levels are also starting to get involved which rarely leads to lower costs or less paperwork but just maybe it will get us safer buildings.
Triple-net real estate investment owners often take a lower rate of return, sometimes in the 5-7% annual range, with increases every five years, long 20-30-year leases, and credit tenants or strong franchises just to protect their investment. Many of these investments are absolute triple-net, which covers the owner. If a hurricane tears down the building or some other catastrophic event occurs, it is up to the tenant and their insurance to rebuild the property. The Covid-19 has thrown a new wrinkle into this equation, as strong franchisees with great brands like Pizza Hut, Wendy’s and others are now filing for Chapter 11 bankruptcy due to the pandemic and the recession. “NPC International Inc., a Kansas-based franchisee that operates 1,225 Pizza Hut restaurants and 385 Wendy’s restaurants, is seeking to restructure as it struggles with at least $1 billion in debt”, as reported by CoStar. This is usually very bad news for the landlord, as it may involve rent reductions or the closure of under-performing locations, regardless of the underlying lease.
There have been a number of reports, both regionally as well as nationally, that predict corporations will begin leasing suburban office space to accomplish several goals. First, they need to increase employee separation during the pandemic, and it is much cheaper to lease space in the suburbs to accomplish this. Secondly, companies that are above the 5th floor in office high-rises have the challenge of getting employees in and out of their office facilities, and with many buildings limiting elevator cab capacity to 2 to 4 people, there may be long lines (six feet apart, wearing masks of course) waiting to ride up in a small enclosed space with strangers who may or may not be positive. Thus, if companies can lease space out where their employees live, they eliminate this danger as well as possibly public transportation as most suburban office space has free parking.
Real Capital Analytics, which tracks national commercial real estate sales, reported on June 25, 2020 that May sales volume was down 79% year over year. Industrial was the best performing category, only down 70%. Office volumes were down 82% and apartments were down 81%. Retail dropped 83%, and all of the above looked comparatively strong as compared to hotels, which were down 95%.” Expect June figures to be even worse.” There are major investment groups putting together scavenger funds to go after distressed properties but many believe that window of opportunity is still a long way out in the future, which means we are nowhere near the bottom…sorry!
San Francisco has over 4.5 million square feet of available office space for sublease, and some brokers are predicting that this may cause direct office space rents to drop by as much as 10-20%. The Covid-19 is not the only reason for this spike in available space. There were a number of new office projects under construction, and some firms taking new space may have had remaining leasehold terms to put on the market. San Francisco has gotten expensive, and with a slew of new business taxes on the County Supervisors radar, firms are expanding or relocating outside of California. Many companies have their employees working from home, and some have made this permanent. “Pandemic-related or not, San Francisco now has the highest sublease availability rate in the country, significantly outpacing the second-place San Jose, according to Jesse Gundersheim, director of market analytics for Costar Group. “Offices are listed at an approximate 12% discount for space that is available directly from a landlord. Businesses now face unprecedented challenges that could curtail demand and lead landlords to lower rents significantly for the first time in over a decade.”
As reported in Fox News on June 22, 2020, real estate entrepreneur Don Pebbles predicted New York based companies are likely to reduce their brick-and-mortar office space in favor of remote working. “What happened with COVID-19 is, it accelerated nationally…because it compelled most Americans, certainly office workers, to work remotely. What business owners, entrepreneurs, and CEO’s found out is that it was an effective way to work…Now people can work from all over the world and they don’t have to be in the same geographic location of where their job is located. That will open up a greater talent pool for businesses to make it more cost-effective…I think we are going to see a lot of people not go back to the city and work remotely. Maybe workers go in once or twice a week, max.”
“By 2021, a new blended workforce will emerge with 20-30% of people working remotely 2-3 days a week.” Employees and clients must feel confident that management is making safety a priority. Buildings will be increasingly automated and touchless, with physical distancing, space utilization apps and health and safety protocols. Remote working will be part of the business strategy. There will be a continued surge in technological innovation. Zoom today, who knows what tomorrow? I have a few thoughts to add to this. I remember after major earthquakes where folks run out and put together a box or two of non-perishables, water, flashlights, and other emergency items, which sits in their garage for the next ten years. It doesn’t get restocked, the water might have gone bad, batteries expired. When we are past this Covad19, will the measures we had to take to survive this pandemic stay with us and cause continued change, or will we slowly morph back into old habits? I do agree that increased remote working is here to stay. What about the huge corporate campuses like the 2.8 million square foot Apple ‘spaceship’ campus which can accommodate 12,000 employees, or the humongous office campus Google is planning for downtown San Jose which with 8 million square feet could possibly accommodate 50,000 employees?
I was so happy to have my 23-year old son Jordan, who lives in San Luis Obispo and is helping run Inspired Flight, an industrial drone company, stay with me twice over the past two months. Those empty nesters know what a joy it is to cook for, try to pamper (although those days may be long gone) and basically hang out with a child you rarely see these days. My daughter Madison, who became an adult in May, is working two part-time jobs and finishing her high school senior year, on-line of course! My father celebrated a wonderful Zoom 95th birthday on September 4th, with friends and relatives from around the world (literally, Australia, Thailand and elsewhere), sharing their thoughts and stories. My better half, Launa, has found the new world of “teaching on Zoom” to be fun, humorous, rewarding and at times exhausting. Her son Ryan, who is a sophomore at UCLA, just finished an intensive 14-unit summer program taking courses for his Film minor. Lindsey spent the summer completing an in-depth language study program in Arabic for her Middle East Peace and Conflict Studies Graduate work. We are both very thankful to have them living in the Bay Area for a few more months.
It will be a most interesting next 45 days between the election and Supreme Court confirmation hearings, no matter what party you belong to. I am not sure either will have much effect on business short-term, which has more than enough to deal with already due to Covid-19 as we enter the Fall and Winter seasons. Please stay safe and cherish your family and friends like never before!
