Since the initial wave of the COVID-19 Omicron variant started to subside, people have begun to return to the office in larger numbers than we have seen since the start of the pandemic. But office owners are still trying to define “return.” In our 2022 commercial real estate trends overview, we explored the on-going struggle between working at the office and working from home; a tug of war not only between landlord and tenants, but between those tenants and their employees.
While we are far from understanding the share of workers that will ultimately return to the office either full-time or only a few days per week, some decline in office demand is likely in almost all markets. What’s new in projecting office occupancy is that tenants are clearly considering the preferences of their workers, a group that previously has not been part of the discussion. As those preferences evolve, perhaps radically, office owners and managers will have to quickly adapt as they strive to maintain occupancy. Predicting the new “normal” is even more urgent: JLL predicts that 243 million of leases will expire in 2022. Tenants may opt for short-term renewals while they consider their office strategies, or immediately reduce their footprint.
Understanding Workers’ Preferences
A recent study by the Pew Research Center of more than 10,000 people sheds light on the way workers are thinking about how they will use office space in the future, which will influence tenant demand. Some highlights of the study include:
Heightened Risk to Office Owners
The data suggests that at the present time there is a strong preference for working at home for at least part of the work week, and it follows that the companies they work for will have to adjust how the organization interacts, communicates, and provides training, mentorship, and career progression for its employees. These companies will want to rethink their space requirements if a significant portion of employees work from home at least two days per week. They will also need to consider whether they will reduce their office footprint when their lease expires, or ask their landlords to make those adjustments before the lease terminates.
Given the already huge volume of lease expirations in 2022, the possibility that other tenants will proactively request lease modifications before term puts office owners and managers in an uncomfortable position. After all, a lease is a contract breakable only in the context of tenant bankruptcy. Owners, their banks, and their equity investors are all relying on rental cash flow for the full term of a lease to meet their obligations – operating and capital expenses, debt service payments, and distributions. Any sudden interruption in contractual revenue can create unanticipated liquidity and valuation risk.
And yet, at least anecdotally, such early requests are happening. Companies that have paid rent for significant periods when the space was empty or only partially occupied are asking their landlords to reduce their space prior to lease expiration. In a few cases companies are filing bankruptcy, and continuing their business as a new entity, just to get out of their lease.
The Need for New Flexible Strategies
Consequently, one facet of the pandemic’s impact on the office sector is the increased need for flexibility on the part of owners to work with and keep their tenants. Of course, the stance of an owner will depend on their view of supply and demand in the market, the competitiveness of the property, the robustness of the current rent roll, and the types and credit quality of tenant businesses currently using the space. The combination of the high volume of lease expirations and tenant requests to reduce space earlier than expiration is accelerating the anticipated risk to office owners resulting from changing work from home preferences.
The Pew study is just one data point in the attempt to measure the full impact of the pandemic on how we work and whether current worker preferences will be short- or long-term. Those preferences will play a larger role in a company’s on-going space requirements, and therefore their conversations with office landlords. In turn, the owners need to be prepared for difficult conversations, and develop strategies for providing flexibility to their tenants while sustaining the economic viability of the properties and mitigating risk.
Source – eisnerramper.com