The 4 Biggest Hybrid Work Challenges for Office Landlords

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Posted by: CMR February 24, 2022 No Comments

The switch to hybrid working for corporate occupiers seems inevitable now. Even as other activities like travel and entertainment have bounced back after the Omicron surge, office attendance hasn’t. But just because employees seem to want hybrid work, that doesn’t mean companies have it all figured out. That might be because there’s no one-size-fits-all roadmap for what hybrid work looks like. The change in work preference will mean a definite impact on office real estate and landlords will face several challenges, whether they are ready or not. 

Most of these changes to the office will be on a tenant-by-tenant basis. A CBRE study examined 42 companies from January through August 2021 occupying more than 350 million square feet of global office space to understand the changing occupancy needs of the hybrid office. Sixty percent of companies were revisiting the design of their workplaces, and more companies are paying close attention to office utilization rates. About 56 percent of companies are also using flex space to supplement office portfolios. Overall, CBRE determined in the report that almost all companies will make changes, large and small, to accommodate employees’ needs in this new hybrid work world.

Perhaps the most significant change is the ‘consumerization’ of the office workplace. This trend was already evident pre-pandemic, but COVID-19 and remote work has accelerated it significantly. Companies are looking at their offices as destinations now that employees can work anywhere. They are competing for employees’ attendance and the competition is fierce: a local cafe, neighborhood library, or the closest couch. This has significant implications for landlords, who will increasingly have to adopt the amenity-rich hospitality mindset to satisfy tenant and employee needs and appeal to the new ‘consumers’ of the office.

Here are the four biggest challenges office landlords will face in transitioning their buildings to the new hybrid working paradigm.

The distributed office

Historically, companies have leased more office space per worker than they needed, a ‘just-in-case’ strategy that helps companies prepare for growth. The switch to hybrid working will change this space planning model. With fewer workers coming in every day, employers will need less space than the sum of their employees. This space will potentially be supplemented with short-term leases at co-working and flex spaces. Seventy-six percent of CEOs said their organizations will use less office space, according to a Fortune/Deloitte CEO Survey. This could lead to significant savings for employers, as real estate and facilities costs are typically one of a company’s top three expenses.

While this seems like dire news for the office, it doesn’t have to be. With the increase in remote employees, employers are also looking at hub-and-spoke models. This entails opening offices in non-core suburban locations that provide better access to employees who don’t always want to travel to the company’s ‘hub’ office downtown. More workers have moved to the suburbs since the pandemic started, so this is another way to retain talent and accommodate them. It’s possible landlords can cash in on this trend by offering both impressive main office and functional ‘spokes’ in the ‘burbs.

Capital ‘A’ amenities

The pandemic didn’t kill the office. While companies’ office footprints may shrink, there will still be a need for a headquarters, most likely in a downtown business district. CEOs and executives know offices are strategic devices, and to lure workers away from home, they need to be best-in-class. This is creating an increased flight to quality for office buildings where tenants seek new and newly retrofitted spaces with a host of amenities. Tenants want roof terraces, buildings with LEED and WELL certifications, fitness centers, and areas for social events. All these can help attract top-tier talent, especially when competition for workers is stiff.

More green and outdoor space is in demand and new tech tools that enhance collaboration are considered mandatory. Depending on negotiations with tenants, most of these capital improvements will fall on the shoulders of landlords. Landlords and property managers will increasingly have to adopt a hospitality mindset, utilizing tenant experience apps and other tools to deliver first-class services. This puts newer buildings at a distinct advantage. In many markets, like Austin, Texas, landlords of soon-to-be-delivered offices are seeing upticks in leasing activity compared to older, existing buildings, according to Aquila, a commercial real estate firm. Upgrading older buildings will come with a cost, but they should be worth it, upgrading offices with the latest in-demand amenities can help frame older buildings as a quality option.

Health = wealth

Speaking of amenities, there’s no bigger one than the increased focus on health and wellness in office buildings. The pandemic has made us more aware of our health and mortality, and the shock from the infectious disease has caused some permanent changes to the way offices are being designed. The phenomenon of healthy buildings is nothing new, but, like with many things, COVID-19 has put the trend in hyperdrive. Indoor air quality (IAQ) will be more of a concern to the office worker of the future, even if they are only in the office part time. Creating a healthy office environment will involve incorporating social distancing into the design, implementing touchless building fixtures, and improving IAQ. Upgrading HVAC systems for better indoor air is perhaps the most important and costly of all the fixes.

These upgrades to create a healthy building will, of course, cost money. But in the post-pandemic world, it may become less of an amenity and more of the new normal and status quo. The more landlords design healthy buildings, the better chances they’ll have to bring in the best, and best paying, tenants. And according to some studies, health and wellness features can help the bottom line. Effective rents at healthy buildings command between 4.4 percent and 7.7 percent more rent per square foot than nearby peer buildings that aren’t WELL or FITWEL certified, according to a study by the MIT Real Estate Innovation Lab.

Tenants have the upper hand

Because of the pandemic and shift to hybrid work, tenants find it challenging to make long-term decisions about their office needs. While some trends seem permanent, there’s still much that’s up in the air. This uncertainty has created the conditions of a strong tenant’s market, where it’s become relatively common for landlords to offer rent abatements and more flexible leasing options. Employers have more leverage during lease renewals, and they may not need as much space. This much tenant leverage won’t last forever, but employers are holding the better cards at the table for now.

For now, though, landlords may have to give more concessions until the market fully recovers. Negotiating lease renewals to temporarily reduce the rent in exchange for a longer lease is one strategy. And providing ‘freebies’ like reduced rent has become very common. “Face rents have not changed since the pandemic, but that’s not the story,” Jeffrey Peck, vice chairman at real-estate brokerage Savills, told The Wall Street Journal. “The story is the fact that landlords are now receiving 20 percent less than what they had been receiving prior to the pandemic.”

If the switch to hybrid work is permanent, like many say, it will present several pressing challenges for office landlords. Employers are reevaluating office space needs like never before, and they have the upper hand in negotiations. Hybrid work is creating the need for offices with better technology, more emphasis on health and wellness, and a long list of amenities. The landlords that stay ahead of these trends and provide these amenities can help weather the transition from the traditional office to the hybrid model. The office market is still not fully stabilized, and it may not be so for a while yet. The next few years will require office landlords to get creative to attract tenants and the new consumers of the hybrid office.

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Author: CMR