A sleepy New York City office market isn’t something anyone envisioned two years ago. But as the COVID-19 pandemic hit, even the most modern of Manhattan’s office towers emptied out. Offices in Los Angeles, Chicago, San Francisco, Boston and other major U.S. cities also have seen a similar shock. And numerous data points suggest this problem isn’t going away.
One change, working from home, looks to become part of the new normal and will leave at least some existing office space vacant, creating uncertainty for the short term. Fortunately, numerous options to attract tenants are open to the owners of office buildings. In turn, commercial mortgage brokers could have more options for clients to stabilize their properties and make them more appealing to lenders for acquisition, refinancing and property-conversion purposes.
First, it is important to discuss the threat facing office properties given the widespread acceptance of remote work. There are advantages to co-workers gathering in an office; however, recent studies show that many companies will embrace a hybrid model post-pandemic. In May 2021, for example, McKinsey & Co. surveyed 100 executives from various locations and industries, and found that nine in 10 respondents plan to combine remote and on-site work models.
This new business model is causing companies to reexamine their office-space needs — especially when owning or leasing in a city where commercial real estate is expensive. With some companies only requiring a few workers in the office simultaneously, they may no longer need as much space.
Facing uncertainty
The immediate shock to demand is clear. Look at the top three U.S. cities based on population — New York City, Los Angeles and Chicago — where vacancy rates have climbed. In midtown Manhattan, the office vacancy rate rose by 6.3 percentage points year over year to reach 19% in second-quarter 2021, according to Cushman & Wakefield. In Los Angeles, the rate jumped 2.3 percentage points to 22.8%, and in Chicago, vacancies climbed by 4.1 percentage points to 22%.
Additionally, according to a July 2021 study by LendingTree and ValuePenguin, these same three cities posted the largest net losses in city-to-city migration. The biggest net gains went to smaller cities such as Phoenix, Austin and Riverside, California. Beyond the immediate impact of COVID-19, the long-term outlook for offices is more muddled.
In a series of “Deep Dive” reports, the Building Owners and Managers Association (BOMA) made a strong case that traditional offices will always remain key in maintaining a cohesive corporate culture. It also cited a Gensler survey that suggested that only 12% of U.S. office workers wanted to stay at home. That said, however, the uses of offices are evolving, and people have been moving outside of city cores into the suburbs and even relocating to other regions.
The BOMA report said one solution may be a hub-and-spoke arrangement, with organizations keeping a prestigious downtown headquarters location while moving some staff to satellite suburban offices or to smaller cities nearby. In Northern Virginia, this was already happening with office hubs in the city of Tysons Corner. The trend may expand post-pandemic to include additional satellite offices farther outside the city or closer to city cores to accommodate various neighborhoods.
Neighborhoods were starting to be part of the picture even before the pandemic. Employees wanted to be in mixed-use communities where people can walk to work, restaurants and other amenities. In Northern Virginia, mixed-use offices where residential, commercial, retail and restaurants coexist have grown and thrived.
Creative solutions
Office buildings can be suitable for numerous types of conversions. One option is to use the building to create apartments in areas where there’s a significant need.
But for these changes to successfully occur, a few things need to happen. One is that local governments must adapt their zoning regulations, allowing commercial spaces to be more easily repurposed. In Arlington, Virginia, for instance, officials are considering revisions to the city’s conversion policies and guidelines. Additionally, local zoning and permitting may need to be altered to allow and even speed up the conversion process. Furthermore, entities in the public, private and government sectors need to come together as partners for these post-pandemic efforts to succeed.
While there are some barriers (zoning, structural issues, permits, etc.) to converting office properties into affordable housing, it makes sense in some areas of the country. In Northern Virginia, there is a critical housing shortage with only a one-month supply as of July. Not surprisingly, the high demand for a limited supply of homes is driving up costs. The median price of a Northern Virginia home was $640,000 in July, almost 70% higher than that of the U.S. median of $385,000 for the same month.
Converting an office building to multifamily housing, however, presents various challenges. This is due to the vast differences between the structural requirements of an office building (mostly open space) and the structural requirements of an apartment building (a combination of open and closed spaces). There also are design, technology, regulatory, financing, zoning and building-code incompatibilities that need to be addressed. These conversions may be desirable, however, because they meet environmental and social needs while providing building owners with revenue.
Office buildings, believe it or not, also can be convenient locales for pop-up shops. These spaces allow the landlord to lease out commercial space on a short-term basis to mitigate income loss. Examples of pop-up shops may include holiday-focused retailers, mobile art exhibits, tax-preparation services or online retailers that want to try selling in person.
Another method to increase occupancy is hot desking. This is a workplace system where desks are used by different people at different times. This is appealing to companies that want to maximize space efficiency and lessen their real estate expenses by reducing redundant office space.
Cast a bigger net
Building owners also may have to ferret out new types of tenants to fill space. One place to start is by looking to growing industries that naturally thrive in a collaborative environment and require people to be in an office. In New York City, for example, some open office space has been leased by life-sciences companies for laboratories, enabling them to bring together most of their employees in a downtown location.
Offices also can be used to host private events. When the pandemic hit, many people were forced to cancel long-anticipated celebrations — from birthdays and weddings to baby showers and retirement parties. In the aftermath of COVID-19, people are clamoring for space to hold private events that were put off for two years. The vacant office could be the key to helping people gather and celebrate safely.
Photographers, videographers and artists often need clean, open space for photo shoots or to display art. These needs are short term and may offer commercial real estate owners a way to cut their income losses. For example, in Crystal City, Virginia, vacant office buildings are being used to showcase the works of area artists.
Like hot desking, office space that was used for corporate purposes could be rented out for smaller meetings or professional training sessions. Again, these short-term leases may not be ideal, but they’re a quick fix to cover some expenses.
Office space also is a good fit for schools and learning centers. According to Fast Company, architect Danish Kurani converted unused office space into a school outside of San Francisco. This conversion is environmentally friendly because it uses space that already exists and doesn’t require an expensive conversion.
Other uses for vacant buildings depend largely on the community and its specific needs. In some cities, vacant buildings have been considered for shelters for abused women; small start-up companies; charter schools; pop-up restaurants; training facilities; medical centers and hospitals; senior centers; self-storage facilities; and recreation and community centers.
The critical component for success in converting a vacant building is flexibility. Working closely with communities and private stakeholders, local governments need to adapt and be flexible to allow the repurposing of commercial real estate.
The pandemic itself has taught us that the ability to change direction can help smooth the path to success — which in this case will be reimagined, vibrant downtown areas. ●
