The U.S. office sector continues to face uncertainty in the wake of the COVID-19 pandemic as numerous companies offer flexible work-from-home policies. This past August, Marcus & Millichap’s Alan L. Pontius discussed the outlook for office buildings with Scotsman Guide.
How has the office sector fared during the pandemic?
Broadly speaking, better than expected, meaning landlords were collecting rents per existing lease terms at a high percentage — at 88% or higher despite most tenants not occupying space. Operationally, office properties with existing leases have done quite well. But we’ve certainly seen a delayed return to the office. We’ve seen examples of companies returning space. We’ve seen examples, particularly in major cities like San Francisco and New York, of sublease space being offered to the market. So, it’s clearly been a hit to the office market.
How will the work-from-home trend affect the sector?
There’s going to be an evolution. You will be seeing companies offer flexible schedules. Companies will not expect their employees to be in five days a week for the traditional 40-hour schedule because talent, which companies compete for, will gravitate toward those companies that recognize long commutes five days a week are counterproductive.
There will be some flexibility, however. There will be what I would call “order to the flexibility.” People won’t just show up whenever they want. Each company will have to figure out its own cadence, its own policy, but you’ll see an evolution with some form of structured flexibility in most companies. And at the end of the day, that doesn’t, in my opinion, lead to net shrinkage of demand for office space.
One case in point: Twitter announced that it would offer employees permanent work-from-home (status) if they wanted, yet Twitter just signed a brand-new lease in Oakland, California, because they don’t want to force all employees to come into San Francisco. So, they needed space in Oakland. Even though Twitter announced it would allow for permanent work from home, it is expanding its office footprint simultaneously.
Are short-term leases here to stay?
In the short term, say 12 to 18 months, there will be a lot of extensions to existing leases. This is more typically the case with midsize to larger companies, more so than smaller regional firms, because midsize and larger companies are closely considering exactly how they want to configure their office space over the longer term.
When I say “configure their space,” part of it is asking, how do we use the space in the literal sense? But part of it is, do we want, instead of one large office, a series of smaller offices spread out in different regions? Do we want to go suburban and not be so dependent on the city core? There are all kinds of evaluations taking place. Consequently, a lot of companies are seeking short-term renewals to better figure this out.
Do you expect much office-investment activity in the coming year?
There already has been a relatively healthy level of office buildings changing hands. Investors have become progressively more interested in suburban properties. We’re seeing a suburban renaissance not terribly different than what we saw in the 1980s. Part of that is the pandemic, but the most important factor is demographics, with millennials moving into the suburbs to raise families.
Consequently, many investors are looking at suburban offices. Another thing that sells office space is what we refer to as a weighted-average lease term. If I’m buying or valuing an office building, and it has a considerable term left in leases and a reasonable level of credit strength with those tenants — and if I believe it has other characteristics, such as location and the building is in good condition — then I’m buying that building today where I have lease protection for four or five years.
I’m willing to make a bet as an investor that office supply-and-demand fundamentals will strengthen in the years ahead as the pandemic finally wanes. There’s ample liquidity for office buildings today and they are trading. ●