CORPORATE OFFICE PERSPECTIVES | APRIL 1, 2022
April 1, 2022
Issue: 251
Across the United States in many regions’ office occupancy is slowly returning as workers come back to the office. In several sub-regions my fellow brokers reported no decline in leasing throughout much of the pandemic, in part due to the exodus from California of office workers seeking lower-cost environments. There are even a number of areas where they are again building new office buildings. As many of these are designed with the latest bells and whistles and may be safer working environments companies are lining up to lease, in spite of the higher rental rates. Here in Northern California, we have two different office worlds, with Silicon Valley leasing space at rates higher than pre-Covid, as compared with San Francisco with a 19% vacancy rate and still many millions of square feet for sublease. How workers will work is all over the board, as seen by my comments and quotes below. No ‘one size fits all’, and for the next few years we may have a wide assortment of working environments to choose from. In one respect this may be healthier than making everyone do the same thing…work from home, sure…work in the office, sure…hybrid, sure…just get the job done and enjoy life at the same time!
Major Office Building Investment Goes Back to The Lender
I am not sure if this is a harbinger of what might be coming down the road, but Blackstone, one of the world’s largest owners of real estate just gave the keys of 1740 Broadway, New York, to a special servicer on its $308 million dollar loan. It paid $605 million for the building in 2014 but lost two huge tenants. The cost of tenant turnover can be immense, and Manhattan has an office vacancy rate over 17%. It might take a year or two to find replacement tenants and even then, the tenant improvement expense could be in the $100-125/rsf range. Bisnow reported “Blackstone’s decision to cut its losses at 1740 Broadway echoes recent moves in Chicago, another office market suffering from macroeconomic shifts. Last week, two towers each spanning over 1M SF were on track to find themselves in the hand of lenders, according to CMBS tracking firm Trepp…The problems going forward are going to come from primarily markets that have sizable amounts of dated properties that are not particularly desirable to big drivers of demand these days,” Trepp Senior Managing Director Manus Clancy told Bisnow in January. “You’ll see episodes in New York, Chicago and other places where big buildings that back loans with nine-figure balances become distressed.”
Employees Prefer Remote Work Over Promotion, and 50% Said They Would Look for New Job If Required To Return Full-Time to Office
On March 21, 2022, Bisnow published report that “Half of all companies plan to require full-time in-person work within a year. There seems to be a major disconnect between what employees want and what employers want…perhaps there will be two types of companies with two types of workers, those that require workers to be in the office, and find those employees happy with this arrangement, and then the rest of the companies that will be more flexible with where their employees work…it would be interesting to see which group is more productive. I have been coming into the office daily for the past 18 months, but I live ten minutes from my office…if I had a nasty commute or didn’t have a great group of associates, I team up with on a regular basis perhaps I would be working from home more. The great thing is with modern connectivity, hardware, software, cloud etc. we have a choice how we want to work and live. This would not have been practical twenty years ago.
Roblox Leasing 430,000 square feet of San Mateo Office Space
This has huge implications not just as a major office deal, but one that was signed while we are still struggling to get workers back into the office. Additionally, this is a major signal to the world that despite high income taxes, high energy costs, high housing costs, a homeless problem the San Francisco Bay Area is still one of the premier places in the entire world to do business in. Having some of the best weather in the United States, with over 100 colleges and universities located just in Northern California, over 1,000 wineries within a two-hour drive, world-class skiing, surfing, hiking, camping, theater and on and on and on there is no other place I personally would want to live. And that is why major corporations are still signing major lease and sale commitments. Yes, we have sent a few of our companies off to Austin, Florida and Nashville, but major tech companies like Apple, Facebook, Google and others have just in the past nine months committed to millions of square feet of additional office space here!
Will Bagels, Massages and Live Entertainment Bring Workers Back to Their Offices?
Around the United States office occupancy levels are in the 40-60% range, but out in San Francisco it is in the 22-35% arena. San Francisco leaders are attempting to jump-start the return to the office, which has impacted the many restaurants and retailers who miss the foot traffic as well as major employers paying for office space while their workers stay home. The Mayor of San Francisco, London Breed, teaming up with Salesforce, Uber, Wells Fargo, Bank of America and other major employers, are bringing music, entertainment, outdoor fitness, specialty foods at the major Downtown San Francisco business districts. I’ve been solicited by companies that offer to set up free massages, hair styling, and other amenities inside office facilities as further enticements to bring employees back from their home offices to come to downtown. But, as the San Francisco Business Times stated today, “A bagel doesn’t make me want to ride the train for two hours.”
Office Building Conversion to Homeless Housing
I don’t see this as a new national trend to take care of two problems at once but in San Pablo, a city in Northern California, a small two-story office building is being converted to 54 small apartments, in this region office vacancies went up from almost 10% to 18%. “There’s just a ton of opportunity out there to use some of these less-than fully occupied buildings and reposition them as part of our broader housing solution”, said David Garcia, policy director for UC Berkeley’s Terner Center for Housing Innovation.” The conversion cost is estimated at $19 million, which works out to $351,000 per studio or one-bedroom unit. Ouch! I also read about a planned Oakland development of around fifty 300 square foot min-homes that will be built at a cost of $350,000 each. This is crazy. There are communities around the United States where for that price you get a 2,500 square foot four-bedroom three bath home with a decent-sized yard.
New Office Construction May Get A 64% Rent Premium
GlobeSt.com 1/22/22 reported that new office building construction was getting a 65% rent premium over average Class A rents, according to a study just out by Cushman & Wakefield. Peter Curry, real estate partner with Farrell Fritz, told GlobeSt that “front and center will be state-of-the-art air filtration systems, energy savings infrastructure, and a retreat from open-space planning. But they will also need to help tenants adapt to an employee base that will almost certainly work remotely for part of each work week.” I have been seeing more articles on four-day workweeks, but the overall consensus appears to be Tues/Wed/Thurs in the office. There have also been a flurry of articles strongly predicting a return to the office starting this April, mandated by employers. At the same time Bill Gates is predicting there will be more serious Covid variants that we will have to react and deal with. Perhaps when you take your masks off, don’t burn them but keep them in storage…
The U.S. Office Market Is Improving!!
According to a report just out by Colliers, the U.S. office vacancy leveled off in Q4 2021, net absorption increased and was positive for the second successive quarter, sales volumes are approaching pre-pandemic levels, and ‘California and Florida are projected to lead the economic recovery’. Yeah! Sublease space levels declined but are still way up there, and while asking rental rates continue to hold firm, landlord concessions increased. A great time to be an office tenant so call your favorite tenant rep (or call me) and take advantage of this market while the window is still open!
New Office Building Systems Can Track Who You Are, Your Vaccine Status, and Where You Go
There appears to be a number of apps out that can allow employees to upload their vaccination status, employment information that then allows a touchless building access through the lobby without having to check in with security. These apps allow you to control the elevator to get you to your specific floor and can monitor where in the building you are at, supposedly to allow management to better optimize the usage of their office facilities. If no one uses a certain number of small conference rooms perhaps convert them to something that gets more usage. If there are areas of the floor that at certain times of the day are unused, perhaps turn off the HVAC, or reduce janitorial to reflect this. If someone is hiding out in the stairwell, smoking or whatever, instead of sitting at their workstation pounding their computer keyboard, maybe send out security to check on them. Joe Gose of The New York Times 2-16-22 wrote “The New York developer Silverstein Properties introduced a contactless entry system for tenants at 7 World Trade Center in Manhattan that allows employees to use badges stored in Apple Wallet to gain access to office and amenity spaces. And at Deutsche Bank’s new offices in the former Time Warner Center, vaccination status is loaded onto employee badges for entry through its turnstiles.” ‘In addition to the apps, permanent but discreet temperature and body scanners and air sensors in lobbies and elsewhere could become more commonplace, especially if other airborne viruses or more coronavirus variants emerge.’ On February 16, 2022, The Registry cited a survey by Density, Inc. that reported nearly two-thirds (61%) of employees at companies with a workforce of more than 1,000 employees would be concerned about their privacy if their company used camera-based technology in the office to monitor how space is being used.
San Francisco’s Office Vacancy Rose To 22.4% in Q-4 2021
This is the highest it has been in 20 years. Even though net absorption is down, rental rates have only dropped 10-15% since the beginning of the pandemic. Landlords are holding firm on their asking rents, although there are still concessions in the form of free rent and tenant improvement allowances. John Bryant, CEO of the Building Owners and Management Association, said ‘that the city’s ongoing struggles with addressing crime and quality of life issues have not helped in terms of incentivizing employees’ return to the office, and that with an increased desire on behalf of many employees to work remotely, the city will have to give people other reasons to spend time downtown.’ Just thinking what that could be…free food vouchers for lunch, bringing in masseuses, allowing workers to bring their dogs to work, free dry cleaning pick up at the office, getting points for every day you show up at the office and being able to redeem the points for premier concert seats, Disneyland vacations, or other perks? What would entice you back to the office?
The Major Corporations Will Determine When Workers Go Back
Wells Fargo had announced that March 14, 2022, was the magic day when employees can return to the office under a ‘hybrid flexible work model’ and that if they want they can come back earlier, starting this Wednesday. They reminded workers that almost 100,000 workers never left the workplace or have already returned, out of almost 250,000 employees. Meanwhile, in the ten major U.S. cities occupancy was 33% of pre-pandemic levels. Compare this with movie theater attendance at 58%, restaurants at 75% and air travel at 80% of comparable pre-pandemic levels. In San Francisco less than 20% of workers returned to the office. Nationwide office building landlords are trying to come up with ways to ‘rekindle the spark to encourage workers to come back to their desks.’ As CEO Craig Deritetzweig of Marx Realty stated, “we want our office space to have those special moments and special places what you can kind of cuddle up and have your cappuccino in the morning.” Yeah, right…what about working from home in your PJ’s with your own cappuccino machine paid for out of the gas savings from not having to commute…
Office Occupancy Up To 36% But Office Demand May Be Stalled. Will Free Massages Help?
Bisnow Jan. 23, 2022, reported national office occupancy rates, which had risen to 39% in November, 2022, is slowly back on the rise and now averages 36%. However, the demand for office space has stalled and is at 58% of pre-pandemic levels. It had hit 87% in August 2021 when we thought we were out of the Covid woods and headed back to normality, but then dropped off the later part of 2021. “Of the companies that have their workplace strategies figured out, it seems many of them are taking the hybrid route. Stanford University economics professor Nick Bloom told The Atlantic he talks to hundreds of companies about remote work and 95% of them say they are going hybrid. The remaining 5% are going fully remote, he said”. I just received an email advertisement for a company that offers services to entice office employees back to the office, including massage, manicures, yoga, meditation, haircuts and more…
The San Francisco Office Market Strong Class A Trophy, Weak Otherwise
Carter Kennedy, one of Colliers top Occupier Services gurus in our San Francisco office, sent me a report on their market. On the one hand, Multi-tenant Class A Trophy office buildings are doing quite well with a vacancy rate of only 4.4%. Many are net leased to strong credit companies. On the other hand, Multi-tenant Class A minus buildings are more challenged and landlords are forced to be more aggressive with their rates and incentive packages. The vacancy rate for this subgroup is over 25%. The forecast for 2022 and 2023 is continued flight to quality, trophy assets will command premium rents, and average rents are expected to decline as negative absorption continues and subleases come back on the direct market.
Three Factors Impacting Return-to-the-Office
A recent article in the San Francisco Business Times listed the three main factors impacting the return to the office. #1, Covid uncertainty…companies have announced, then cancelled, then announced again only to cancel again plans to bring employees back to the office. “Experts say they fully expect additional variants to follow Omicron, which is keeping many businesses in a state of limbo.” #2, the Hiring Market…” Whether it’s COVID-19 safety concerns, work-life balance issues, childcare needs or a combination of several factors, many just don’t want to return to the office – even just a few days a week as part of a hybrid setup.” #3 The Office Isn’t The Same…” average U.S. office capacity reached 25% in October, which was the highest point since prior to the pandemic…the number of employees spending at least one day at the office increased, but employees were spending less time in the office on the average.” So, you want to give employees flexibility in deciding which days they will come to the office while at the same time trying to get synergy with everyone being there at the same time. One compromise is designating one day a week as ‘the’ office day and then allowing employees to pick their other days on their own.
The Office Market Is Seeing Both Directions At the Same Time!
A few weeks ago, Sephora sublet 286,000 of high-end San Francisco office space from Salesforce. Ah, a positive sign for the market! Our Colliers SF Office report noted that ‘Overall effective rents rose to $78.56/rsf due to larger leases signed in trophy Class A assets’. Direct and sublease vacancy combined is now 23%.
As Star Trek Said, Space…The Final Frontier!”
Yesterday Slack’s CEO called ‘Return to Work a Doomed Approach’ and put 208,000 square feet of space on the San Francisco sublet market. The SF Registry reported on Slack, “Communication software firm Slack has decided that the future of work is not necessarily in the office and has placed 208,460 square feet of space on the sublease market in San Francisco.” When I see headlines about CEOs trying to lure employees back to the office, I feel like it’s probably a doomed approach,” explained Slack CEO and Co-Founder Steward Butterfield to the Washington Post in December. “Work is no longer a place you go, it’s something you do.” Slack’s current headquarters, at 300 Howard, has a capacity for around 1,000 people but only sees about 30 employees on any given day. Slack says that for new remote hires and for those who have moved away from offices, it will not ask employees to return and will continue to implement a ‘digital first’ workplace strategy.” Recently Merrill Lynch announced it was putting 102,000 square feet on the San Francisco sublease market.
International Office Rental Rates
In a recent comparison of Class A office rental rates around the world, Central Hong Kong took first place at around $225/rsf per year, followed by midtown New York at $190, Beijing at $185, London at $125, and way down the list, San Francisco at only $75/rsf. At the other end of the spectrum, there are Class A office buildings in the Eastbay where $30-35/rsf, full serviced with free conference and fitness facilities and free garage parking.
On a personal note, we have so much to be grateful for. Between Launa’s Union Square timeshare in San Francisco for a romantic Valentine’s Day weekend, and short trips to her condo in Lake Tahoe, we have been able to enjoy all the magic Northern California has to offer. I have also enjoyed a few ski trips with friends the past couple of months. Launa’s mom just recovered from a broken back and is healing at home in Incline Village. Jordan is still helping run an industrial drone company in San Luis Obispo, and if you want the best $30-50,000 drone with all the bells and whistles call him at Inspired Flight. My other child is at DVC, loves competitive soccer, camping, and playing guitar. My stepdaughter, Lindsey, is working 2 jobs, having a blast with friends, and working on her Master’s degree at Georgetown in Washington DC. My stepson, Ryan, loves being back on campus for math and film classes at UCLA. Arthur is happy, healthy and active. He reminds me he is not just 96, but 96 ½, will be 97 this September and takes Uber to the City to see musicals and concerts, even though we caution him to slow down. Between chair volleyball, working out daily with his trainer, attending discussion groups, playing Rummikub every few days, watching every Warriors game and working on his 23rd book, Arthur does complain that his mind wants to do more than his body…oh well!
Live full, be safe, pray for Ukraine, and call me if I can help with your commercial real estate needs in any way!
