There is always investment money ready to make a bargain. Office owners, managers and brokers can rely on this in these difficult times.
At the start of 2020, office buildings seemed ready for another solid year. 2020 should improve twelve years in a row since the last recession. The vacancy rates had fallen steadily, from 16.5% in 2009 to 12% just before the pandemic. What derailed this series – unprecedented job losses, the biggest economic stimulus ever, and the move to remote working and video conferencing – will continue to affect office space for years to come.
Even if many states move into the next phase of reopening, office buildings across the country will be empty. Many office workers are reluctant to go back to work. More and more companies are announcing flexibility from home by the end of the year or even until 2021.
In contrast to the retail sector, where many small businesses in the city center or large department stores in closed shopping centers and therefore do not pay rents, office rents are for the most part still paid even when the space is not used. Given stock prices, some companies, like the big tech and biomedical industries, are booming and expanding amid the pandemic. The expansion of the office space is not taking place among these companies either.
Why price cuts have to make sense
Nationwide, as of the end of June, there were 2.07 million fewer jobs in sectors that include financial activities and professional business services, industries where office space is heavily used. This corresponds to an 8% reduction in office jobs and a corresponding 8% reduction in office space requirements. Such a change would correspond to a vacancy rate of around 400 basis points to 16%, which essentially goes back to the last level of the recession in a very short time. Even if the economy were to grow rapidly and return to peak employment, for example in the next 24 months, which is reasonably possible, the demand for office space is unlikely to increase significantly. Aside from the expansion of remote working, there was already plenty of new space on the market at the beginning of the year and will continue to do so, as office construction cannot be stopped in the middle of the stadium. Spending on new office construction amounted to an annual rate of $ 72 billion in the months leading up to the pandemic, well above the average of $ 45 billion over the past 20 years.
Not only has leasing almost been discontinued, but the buying and selling of commercial buildings will also not take place during the pandemic. Large expensive real estate transactions (for buildings priced above $ 2.5 million) fell a whopping 68% year over year in the second quarter of this year. The decline in sales was less pronounced for more affordable buildings, partly due to the frozen conditions in the large city centers and increased interest in suburbs and smaller towns.
To do business, owners might consider cutting the price quickly in anticipation of higher vacancy rates and lower rents. At least 15% off the top price can be appropriate. That change isn't that painful, after all, considering that office property prices have essentially doubled over the past decade. Some may hope that the extremely low interest rates, which should be with us for at least the next few years, will more than make up for falling office rental income. However, the reality of remote working will cause caps to rise and prices to fall. Rents will be pressured to drop 10% in 2020 to attract new tenants.
The limits of video conferencing
One wild card that goes well into the future is how much of the current remote work will be permanent. Before the pandemic, only 5% of the workforce was mainly working from home. The new reality could be up to 20%. Labor productivity research has consistently shown no loss of productivity from remote working with repetitive or similar tasks.
But how well will companies innovate without personal collaboration? New ideas lead to new products and services. However, video conferencing collaboration is cumbersome at best. In group interactions, it is less clear when to bring your thoughts to that critical half-second pause – or how to use body language to quickly move the conversation forward so as not to disagree or agree with other participants during the discussion. The video does not allow conversations with the water cooler that lead to new thoughts that are not even considered before you arrive at the office in the morning. This type of communication is the stuff of business momentum for future growth.
If companies find that office workers are the key to growth and survival, then we can assume that demand for offices will increase in line with overall employment growth. Otherwise, you approach transactions with the expectation of a sluggish recovery.